**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**Form
      10-K**





For
      Annual and Transition Report Pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934




[X]                    
        Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
        Act of
        1934
 For
        the
        fiscal year ended December 31, 2006.
 or
 [  ]                 
           Transition Report Pursuant to Section 13 or 15(d) of the Securities
          Exchange Act of 1934
 For
          the
          transition period from ________ to ________




Commission
      File Number **0-49731**





**SEVERN
      BANCORP, INC.**


(Exact
      name of registrant as specified in its charter)





**MARYLAND**
            **52-1726127**(State
                or other jurisdiction
            (I.R.S.
                Employer Identification Number)of
                incorporation or organization)**200
                Westgate Circle, Suite 200, Annapolis,
                Maryland**
            **21401**(Address
                of principal executive offices)
            (Zip
                Code)





Registrant's
      telephone number, including area code: **** **(410)
      260-2000**




Securities
      registered pursuant to Section 12(b) of the Act:




Title
                  of Each Class
              
              Name
                  of Each Exchange on Which RegisteredCommon
                  Stock, par value $.01 per share
              
              The
                  Nasdaq Stock Market, LLC





Securities
      registered pursuant to Section 12(g) of the Act: None








Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes [ ] No [X]





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes [ ] No [X]





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes [X] No [ ]





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (section 229.405 of the chapter) is not contained herein, and
      will not be contained, to the best of registrant’s knowledge, in definitive
      proxy or information statements incorporated by reference in Part III of this
      Form 10-K or any amendment to this Form 10-K. [ ]











Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      on):




Large
      accelerated filer [ ]   Accelerated
      filer [X]   Non-accelerated
      filer [ ]





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule12b-2
      of the Act).


Yes
      [ ]
      No [X]





The
      aggregate market value of the voting stock held by non-affiliates of the
      registrant, based on the closing sale price of the registrant’s common stock on
      June 30, 2006 was $81,941,427 ($18.97 per share based on shares of common stock
      outstanding at June 30, 200 6).





(APPLICABLE
      ONLY TO CORPORATE REGISTRANTS)





Indicate
      the number of shares outstanding or each of the registrant’s classes of common
      stock, as of the latest practicable date.





As
      of
      March 1, 2007, there were issued and outstanding 9,150,850 shares of the
      registrant’s common stock.





**Documents
      Incorporated by Reference:** Portions
      of the definitive Proxy Statement in connection with the Annual Meeting of
      Shareholders.












**Table
      of Contents**





***Section***
            
            ***Page
                No.*****PART
                I**
            
            1**Item
                1**
            **Business**
            1**Item
                1A**
            **Risk
                Factors**
            31**Item
                1B**
            **Unresolved
                Staff Comments**
            35**Item
                2**
            **Properties**
            35**Item
                3**
            **Legal
                Proceedings**
            35**Item
                4**
            **Submission
                of Matters to a Vote of Security Holders**
            35**Executive
                Officers of the Registrant That Are Not Directors**
            35**PART
                II**
            
            36**Item
                5**
            **Market
                for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                Purchases of Equity Securities**
            36**Item
                6**
            **Selected
                Financial Data**
            38**Item
                7**
            **Management’s
                Discussion and Analysis of Financial Condition and
                Results of Operations**
            42**Item
                7A**
            **Quantitative
                and Qualitative Disclosures About Market Risk**
            48**Item
                8**
            **Financial
                Statements and Supplementary Data**
            49**Item
                9**
            **Changes
                in and Disagreements with Accountants on Accounting
                and Financial Disclosure**
            49**Item
                9A**
            **Controls
                and Procedures**
            50**Item
                9B**
            **Other
                Information**
            54**PART
                III**
            
            54**Item
                10**
            **Directors
                and Executive Officers of the Registrant and Corporate
                Governance**
            54**Item
                11**
            **Executive
                Compensation**
            54**Item
                12**
            **Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters**
            55**Item
                13**
            **Certain
                Relationships and Related Transactions, and Director
                Independence**
            55**Item
                14**
            **Principal
                Accountant Fees and Services**
            55**PART
                IV**
            
            56**Item
                15**
            **Exhibits
                and Financial Statement Schedules**
            56**SIGNATURES**
            
            57





i





**SPECIAL
      NOTE REGARDING FORWARD-LOOKING STATEMENTS**





Severn
      Bancorp, Inc. (“Bancorp”) may from time to time make written or oral
“forward-looking statements”, including statements contained in Bancorp’s
      filings with the Securities and Exchange Commission (including this Annual
      Report on Form 10-K and the exhibits thereto), in its reports to stockholders
      and in other communications by Bancorp, pursuant to the “safe harbor” provisions
      of the Private Securities Litigation Reform Act of 1995.





In
      addition to the historical information contained herein, the following
      discussion contains forward-looking statements that involve risks and
      uncertainties. Bancorp operations and actual results could differ significantly
      from those discussed in the forward-looking statements. Some of the factors
      that
      could cause or contribute to such differences include, but are not limited
      to,
      changes in the economy and interest rates in the nation and Bancorp’s general
      market area. The forward-looking statements contained herein include, but are
      not limited to, those with respect to management’s determination of the amount
      of loan loss allowance; the effect of changes in interest rates; and changes
      in
      deposit insurance premiums.





Bancorp
      disclaims any intent or obligation to publicly update or revise any
      forward-looking statements, regardless of whether new information becomes
      available, future developments occur or otherwise.




















ii


**PART
      I**





**Item
      1. Business**





**General**





Bancorp
      is a
      savings and loan holding company chartered in the state of Maryland in 1990.
      It
      conducts business through three subsidiaries: Severn Savings Bank, FSB (“Bank”),
      its principal subsidiary; Louis Hyatt, Inc. (“HC”), which is doing business as
      Hyatt Commercial, a commercial real estate brokerage and property management
      company; and SBI Mortgage Company (“SBI”), which holds mortgages that do not
      meet the underwriting criteria of the Bank, and is the parent company of
      Crownsville Development Corporation (“Crownsville”), which is doing business as
      Annapolis Equity Group (“AEG”), which acquires real estate for syndication and
      investment purposes.





On
      December 17, 2004, Bancorp acquired all the common stock of newly formed Severn
      Capital Trust I, a Delaware business trust. Severn Capital Trust I issued
      $20,000,000 of trust preferred securities in a private placement pursuant to
      an
      applicable exemption from registration under the Securities Act of 1933, as
      amended. Bancorp irrevocably and unconditionally guarantees the trust preferred
      securities. The proceeds of the trust preferred securities were used to purchase
      subordinated debentures of Bancorp.





The
      Bank
      has four branches in Anne Arundel County, Maryland, which offer a full range
      of
      deposit products, and originate mortgages in its primary market of Anne Arundel
      County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware
      and Northern Virginia.





As
      of
      December 31, 2006, Bancorp had total assets of $911,916,000, total deposits
      of
      $626,524,000, and total stockholders’ equity of $86,442,000. Net income of
      Bancorp for the year ended December 31, 2006 was $15,748,000.





Bancorp’s
      internet address is www.severnbank.com. Bancorp makes available free of charge
      on www.severnbank.com its annual report on Form 10-K, quarterly reports on
      Form
      10-Q and current reports on Form 8-K, and amendments to those reports filed
      or
      furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as
      reasonably practicable after it electronically files such material with, or
      furnish it to, the SEC.





In
      addition, we will provide, at no cost, paper or electronic copies of our reports
      and other filings made with the SEC. Requests should be directed
      to:





S.
      Scott
      Kirkley


Executive
      Vice President


Severn
      Bancorp, Inc.


200
      Westgate Circle, Suite 200


Annapolis,
      Maryland 21401





The
      information on the website listed above, is not and should not be considered
      part of this Annual Report on Form 10-K and is not incorporated by reference
      in
      this document. This website is and is only intended to be an inactive textual
      reference.





























1





**Business
      of the Bank**







The
      Bank
      was organized in 1946 in Baltimore, Maryland as Pompei Permanent Building and
      Loan Association. It relocated to Annapolis, Maryland in 1980 and its name
      was
      changed to Severn Savings Association. Subsequently, the Bank obtained a federal
      charter and changed its name to Severn Savings Bank, FSB. The Bank operates
      four
      full-service branch offices, one administrative office and one accounting and
      servicing office. The Bank operates as a federally chartered savings bank whose
      principal business is attracting deposits from the general public and investing
      those funds in mortgage loans. The Bank also uses advances, or loans from the
      Federal Home Loan Bank of Atlanta, (“FHLB-Atlanta”) to fund its mortgage
      activities. The Bank provides a wide range of retail and mortgage banking
      services. Deposit services include checking, savings, money market, time deposit
      and individual retirement accounts. Loan services include various types of
      real
      estate, consumer, and commercial lending. The Bank also provides safety deposit
      boxes, ATMs, debit cards, internet and telephone banking.





The
      Bank’s revenues are derived principally from interest earned on mortgage loans,
      fees charged in connection with the loans and banking services, and gains
      realized from the sale of mortgage loans. The Bank’s primary sources of funds
      are deposits, advances from the FHLB-Atlanta, principal amortization and
      prepayment of its loans. The principal executive offices of the Bank are
      maintained at 200 Westgate Circle, Suite 200, Annapolis Maryland, 21401. Its
      telephone number is 410-260-2600 and its e-mail address is mailman@severnbank.com.





In
      addition to its deposit and lending activities, the Bank offers title insurance
      and real estate settlement services through its wholly owned subsidiary,
      Homeowner’s Title and Escrow Corporation (“Homeowner’s”).





As
      of
      December 31, 2004, the Bank owned all of the Common Stock of Severn Preferred
      Capital Corporation (“Severn Capital”). On December 22, 2004, the Bank announced
      it was liquidating Severn Capital and redeeming the outstanding preferred stock
      at $20 per share on January 31, 2005. Severn Capital was a real estate
      investment trust that issued and had outstanding 200,002 shares of Series A
      Preferred Stock. The preferred stock had an aggregate outstanding balance of
      $4,000,040 at December 31, 2004, which qualified as regulatory capital of the
      Bank. The Series A Preferred Stock paid a 9% annual non-cumulative dividend.
      On
      January 31, 2005, the Bank liquidated Severn Capital and redeemed the
      outstanding preferred stock at $20 per share.





**The
      Thrift Industry**





Thrift
      institutions are financial intermediaries which historically have accepted
      savings deposits from the general public and, to a lesser extent, borrowed
      funds
      from outside sources and invested those deposits and funds primarily in loans
      secured by first mortgage liens on residential and other types of real estate.
      Such institutions may also invest their funds in various types of short- and
      long-term securities. The deposits of thrift institutions are insured by the
      Savings Association Insurance Fund (“SAIF”) as administered by the Federal
      Deposit Insurance Corporation (“FDIC”), and these institutions are subject to
      extensive regulations. These regula-tions govern, among other things, the
      lending and other investment powers of thrift institutions, including the terms
      of mortgage instruments these institutions are permitted to utilize, the types
      of deposits they are permitted to accept, and reserve
      require-ments.





The
      operations of thrift institutions, including those of the Bank, are
      significantly affected by general economic conditions and by related monetary
      and fiscal policies of the federal government and regulations and policies
      of
      financial institution regulatory authorities, including the Board of Governors
      of the Federal Reserve System (the “FRB”) and the Office of Thrift Supervision
      (“OTS”). Lending activities are influenced by a number of factors including the
      demand for housing, conditions in the construction industry, and availability
      of
      funds. Sources of funds for lending activities include savings deposits, loan
      principal payments, proceeds from sales of loans, and borrowings from the
      Federal Home Loan Bank (“FHLB”) and other sources. Savings flows at thrift
      institutions such as the Bank are influenced by a number of factors including
      interest rates on competing investments and levels of personal
      income.






2







**Earnings**





The
      Bank’s earnings depend primarily on the difference between income from
      interest-earning assets such as loans and investments, and interest paid on
      interest-bearing liabilities such as deposits and borrowings. The Bank typically
      engages in long-term mortgage lending at fixed rates of interest, generally
      for
      periods of up to 30 years, while accepting deposits for consider-ably shorter
      periods. However, many of the Bank’s long-term fixed-rate loans are sold in the
      secondary market, resulting in gains on the sale of such loans by the
      Bank.





Generally,
      rapidly rising interest rates cause the cost of interest-bearing liabilities
      to
      increase more rapidly than yields on interest-earning assets, thereby adversely
      affecting the earnings of many thrift institutions. While the industry has
      received expanded lending and borrowing powers in recent years permitting
      different types of investments and mortgage loans, including those with floating
      or adjustable rates and those with shorter terms, earnings and operations are
      still highly influenced by levels of interest rates and financial market
      conditions and by substantial investments in long-term mortgage
      loans.





**Competition**





The
      Annapolis, Maryland area has a high density of financial institutions, many
      of
      which are significantly larger and have greater financial resources than the
      Bank, and all of which are competitors of the Bank to varying degrees. The
      Bank’s competition for loans comes primarily from savings and loan associations,
      savings banks, mortgage banking companies, insurance companies, and commercial
      banks. Its most direct competition for deposits has historically come from
      savings and loan associations, savings banks, commercial banks, and credit
      unions. The Bank faces additional competition for deposits from short-term
      money
      market funds and other corporate and government securities funds. The Bank
      also
      faces increased competition for deposits from other financial institutions
      such
      as brokerage firms and insurance companies. The Bank is a community-oriented
      financial institution serving its market area with a wide selection of mortgage
      loans. Management considers the Bank’s reputation for financial strength and
      customer service as its major competitive advantage in attracting and retaining
      customers in its market area. The Bank also believes it benefits from its
      community orientation.





**Net
      Interest Income**





Net
      interest income increases during periods when the spread between the Bank’s
      weighted average rate at which new loans are originated and the weighted average
      cost of interest-bearing liabilities widens. Market factors such as interest
      rates, competition, consumer preferences, the supply of and demand for housing,
      and the availability of funds affect the Bank’s ability to originate
      loans.





The
      Bank has supplemented its interest income through purchases of investments
      when
      appropriate. This activity generates positive interest rate spreads on large
      principal balances with minimal administrative expense.





**Interest
      Rate and Volume of Interest-Related Assets and
      Liabilities**





Both
      changes in rate and changes in the composition of the Bank’s interest-earning
      assets and interest-bearing liabilities can have a significant effect on net
      interest income.




For
      information concerning the extent to which changes in interest rates and changes
      in volume of interest-related assets and liabilities have affected the Bank’s
      interest income and expense during the fiscal years ending December 31, 2006
      and
      2005, refer to Item 6, “Selected Financial Data - Rate Volume
      Table”.





**Market
      Area**





The
      Bank’s market area for deposit gathering is primarily Anne Arundel County,
      Maryland and nearby areas, due to its four branch locations, all located in
      Anne
      Arundel County. The principal business of the Bank is attracting deposits from
      the general public and investing those deposits, together with other funds,
      in
      mortgage and consumer loans, mortgage-backed securities and investment
      securities. The Bank’s revenues are derived principally from interest earned on
      mortgage, consumer and other loans, fees charged in connection with loans and
      banking services, interest and dividends earned on other investments. The Bank’s
      primary sources of funds are deposits and loan interest, principal amortization
      and prepayments.






3








The
        primary
        focus of the Bank’s lending activities has been on first mortgage loans secured
        by real estate for the purpose of purchasing, refinancing, developing and
        constructing one-to-four family residences and commercial properties in and
        near
        Anne Arundel County, Maryland. The Bank does originate mortgage loans throughout
        the state of Maryland, Northern Virginia and Delaware. The Bank is an active
        participant in the secondary market and sells substantially all fixed-rate
        long-term mortgages that it originates.





















4


**Loan
      Portfolio Composition**





The
      following
      table sets forth the composition of the Bank’s loan portfolios by type of loan
      at the dates indicated. The table includes a reconciliation of total
      net
      loans receivable, including loans held for sale, after consideration of
      undisbursed portion of loans, deferred loan fees and discounts, and allowances
      for losses on loans.




2006
            
            2005
            
            2004
            
            2003
            
            2002Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent(dollars
                in thousands)Residential
                mortgage
            $249,448
            26.15%
            
            $219,988
            23.71%
            
            $215,767
            27.30%
            
            $187,498
            30.83%
            
            $142,342
            28.87%Construction,
                land acquisition anddevelopment
            339,122
            35.55%
            
            390,376
            42.07%
            
            343,101
            43.42%
            
            240,757
            39.58%
            
            191,196
            38.77%Land
            90,747
            9.51%
            
            77,319
            8.33%
            
            33,419
            4.23%
            
            25,820
            4.25%
            
            20,109
            4.08%Lines
                of credit
            40,733
            4.27%
            
            35,491
            3.82%
            
            29,096
            3.68%
            
            19,581
            3.22%
            
            12,472
            2.53%Commercial
                real estate
            193,299
            20.26%
            
            163,449
            17.61%
            
            127,768
            16.17%
            
            106,823
            17.56%
            
            90,862
            18.43%Commercial
                non-real estate
            3,348
            0.35%
            
            3,412
            0.37%
            
            3,859
            0.49%
            
            3,813
            0.63%
            
            3,445
            0.70%Home
                equity
            32,758
            3.44%
            
            32,974
            3.55%
            
            28,101
            3.56%
            
            18,391
            3.02%
            
            11,197
            2.27%Consumer
            1,537
            0.16%
            
            1,768
            0.19%
            
            2,489
            0.31%
            
            2,364
            0.39%
            
            3,979
            0.81%Loans
                held for sale
            2,970
            0.31%
            
            3,216
            0.35%
            
            6,654
            0.84%
            
            3,175
            0.52%
            
            17,481
            3.54%Total
                gross loans
            953,962
            100.00%
            
            927,993
            100.00%
            
            790,254
            100.00%
            
            608,222
            100.00%
            
            493,083
            100.00%Deferred
                loan origination fees and costs, net
            (4,712)
            
            
            (4,916)
            
            
            (4,157)
            
            
            (3,344)
            
            
            (2,674)Loans
                in process
            (104,747)
            
            
            (136,239)
            
            
            (123,195)
            
            
            (94,020)
            
            
            (67,593)Allowance
                for loan losses
            (9,026)
            
            
            (7,505)
            
            
            (5,935)
            
            
            (4,832)
            
            
            (3,991)Total
                loans net
            $835,477
            
            
            $779,333
            
            
            $656,967
            
            
            $506,026
            
            
            $418,825








5





**Lending
      Activities**





**General**





The
      Bank
      originates mortgage loans of all types, including residential,
      residential-construction, commercial-construction, commercial and land and
      residential lot loans. To a lesser extent, the Bank also originates non-mortgage
      loans, which include consumer, business and commercial loans. These loans
      constitute a small part of the Bank’s portfolio.





The
      Bank
      originated and funded $285,820,000 and $326,315,000 of mortgage loans for the
      years ended December 31, 2006 and 2005, respectively.





**Loan
      Origination Procedures**





The
      following table contains information on the activity of the Bank’s loans held
      for sale and its loans held for investment in its portfolio:




For
                the Years ended December 31,2006
            
            
            2005
            
            
            2004(dollars
                in thousands)Held
                for Sale:Beginning
                balance
            
            $
            3,216
            
            $
            6,654
            
            $
            3,175Originations
            
            
            31,322
            
            
            73,766
            
            
            74,352Net
                sales
            
            
            (31,568
            )
            
            (77,204
            )
            
            (70,873
            )Ending
                balance
            
            $
            2,970
            
            $
            3,216
            
            $
            6,654Held
                for investment:Beginning
                balance
            
            $
            924,777
            
            $
            783,600
            
            $
            605,047Originations
                and purchases
            
            
            260,715
            
            
            252,525
            
            
            262,278Repayments/payoffs
            
            
            (234,500
            )
            
            (111,348
            )
            
            (83,725
            )Ending
                balance
            
            $
            950,922
            
            $
            924,777
            
            $
            783,600







The
      Bank
      originates residential mortgage loans that are intended for sale in the
      secondary market as well as loans that are to be held in the Bank’s investment
      portfolio. Loans sold in the secondary market are primarily sold to investors
      with which the Bank maintains a correspondent relationship. These loans are
      made
      in conformity with standard underwriting criteria to assure maximum eligibility
      for possible resale in the secondary market, and are approved either by the
      Bank’s underwriter or the correspondent’s underwriter. Loans considered for the
      Bank’s portfolio are approved by the Bank’s loan committee, which includes two
      Executive Vice Presidents. Meetings of the loan committee are open to attendance
      by any member of the Bank’s Board of Directors who wishes to attend. The loan
      committee reports to and consults with the Board of Directors in interpreting
      and applying the Bank’s lending policy, and for loan approval on any single loan
      over $2 million, or loan relationships over $5 million.










Loans
      that are sold are typically long-term (15 or more years) loans with fixed
      interest rates eligible for resale in the secondary market. Loans retained
      for
      the Bank’s portfolio include construction loans, commercial loans and loans that
      periodically reprice or mature prior to the end of an amortized term. Loans
      are
      generally sold with servicing released. However, as of December 31, 2006, the
      Bank was servicing $923,000 in loans for Federal Home Loan Mortgage Corporation
      (“FHLMC”) and $58,869,000 in loans for other investors.





The
      following table contains information, as of December 31, 2006, on the percentage
      of fixed-rate single-family loans serviced for others by the Bank, by interest
      rate category.





Coupon
                range
            
            Percentage
                of PortfolioLess
                than 5.00%
            
            43.3
            %5.01
                - 6.00%
            
            0.0
            %6.01
                - 7.00%
            
            4.0
            %7.01
                - 8.00%
            
            4.1
            %Over
                8.00%
            
            48.6
            %100.0
            %





The
      Bank’s mortgage loan approval process is intended to assess the borrower’s
      ability to repay the loan, the viability of the loan, and the adequacy of the
      value of the property that will secure the loan. The authority of the loan
      committee to approve loans is established by the Board of Directors and
      currently is commensurate with the Bank’s limitation on loans to one borrower.
      The Bank’s maximum amount of loans to one borrower currently is equal to 15% of
      the Bank’s unimpaired capital, or $14,917,000 as of December 31, 2006. Loans
      greater than this amount require participation by one or more additional
      lenders. Letters of credit are subject to the same limitations as direct loans.
      The Bank utilizes independent qualified appraisers approved by the Board of
      Directors to appraise the properties securing its loans and requires title
      insurance or title opinions so as to insure that the Bank has a valid lien
      on
      the mortgaged real estate. The Bank requires borrowers to maintain fire and
      casualty insurance on its secured properties.





The
      procedure for approval of construction loans is the same for residential
      mortgage loans, except that the appraiser evaluates the building plans,
      construction specifications, and estimates of construction costs. The Bank
      also
      evaluates the feasibility of the proposed construction project and the
      experience and track record of the developer. In addition, all construction
      loans generally require a commitment from a third-party lender or from the
      Bank
      for a permanent long-term loan to replace the construction loan upon completion
      of construction.





**Commercial
      Real Estate Loans**





At
      December 31, 2006, the Bank’s commercial real estate loan portfolio totaled
      $193,299,000, or 20.3% of the Bank’s total loan portfolio. All of the Bank’s
      commercial loans are secured by improved property such as office buildings,
      retail strip shopping centers, industrial condominium units and other small
      businesses most of which are located in the Bank’s primary lending area. The
      largest commercial real estate loan outstanding at December 31, 2006 was a
      $4,379,000 loan secured by an office building in Annapolis, Maryland. This
      loan
      has consistently performed in accordance with the terms of the debt
      instrument.





Loans
      secured by commercial real estate properties generally involve a greater degree
      of risk than residential mortgage loans. Because payments on loans secured
      by
      commercial real estate properties are often dependent on the successful
      operation or management of the properties, repayment of these loans may be
      subject to a greater extent to adverse conditions in the real estate market
      or
      the economy.











**Construction
      Loans**





The
      Bank
      originates loans to finance the construction of one-to-four family dwellings,
      and to a lesser extent, commercial real estate. It also originates loans for
      the
      acquisition and development of unimproved property to be used for residential
      and/or commercial purposes in cases where the Bank is to provide the
      construction funds to improve the properties. As of December 31, 2006, the
      Bank
      had 577 construction loans outstanding in the gross aggregate amount of
      $339,122,000, representing 35.6% of its loan portfolio, of which $104,747,000
      was unadvanced.





Construction
      loan amounts are based on the appraised value of the property and, for builder
      loans, a feasibility study as to the potential marketability and profitability
      of the project. Construction loans generally have terms of up to one year,
      with
      reasonable extensions as needed, and typically have interest rates that float
      monthly at margins ranging 1⁄2 percent to 2 percent above the prime rate. In
      addition to builders’ projects, the Bank finances the construction of single
      family, owner-occupied houses where qualified contractors are involved and
      on
      the basis of strict written underwriting and construction loan guidelines.
      Construction loans are structured either to be converted to permanent loans
      with
      the Bank upon the expiration of the construction phase or to be paid off by
      financing from another financial institution.





Construction
      loans afford the Bank the opportunity to increase the interest rate sensitivity
      of its loan portfolio and to receive yields higher than those obtainable on
      loans secured by existing residential properties. These higher yields correspond
      to the higher risks associated with construction lending. Construction loans
      involve additional risks attributable to the fact that loan funds are advanced
      upon the security of the project under construction that is of uncertain value
      prior to its completion. Because of the uncertainties inherent in estimating
      construction costs as well as the market value of the completed project and
      the
      effects of governmental regulation of real property, it is relatively difficult
      to value accurately the total funds required to complete a project and the
      related loan-to-value ratio. As a result, construction lending often involves
      the disbursement of substantial funds with repayment dependent, in part, on
      the
      ultimate success of the project rather than the ability of the borrower or
      guarantor to repay principal and interest. If the Bank is forced to foreclose
      on
      a project prior to or at completion, due to a default, there can be no assurance
      that the Bank will be able to recover all of the unpaid balance of the loan
      as
      well as related foreclosure and holding costs. In addition, the Bank may be
      required to fund additional amounts to complete the project and may have to
      hold
      the property for an unspecified period of time. The Bank has attempted to
      address these risks through its underwriting procedures and its limited amount
      of construction lending on multi-family and commercial real estate
      properties.





It
      is the
      policy of the Bank to conduct physical inspections of each property secured
      by a
      construction or rehabilitation loan for the purpose of reporting upon the
      progress of the construction of improvements. These inspections, referred to
      as
“construction draw inspections,” are to be performed at the time of a request
      for an advance of construction funds. If no construction advance has been
      requested, a fee inspector or senior officer of the institution makes an
      inspection of the subject property at least quarterly.





**Multi-Family
      Lending**





The
      Bank
      occasionally originates multi-family loans with terms up to 30 years, but with
      rate adjustments or balloon payments generally at three to five years. These
      loans are generally made in amounts up to 75% of the appraised value of the
      secured property. In making these loans, the Bank bases its underwriting
      decision primarily on the net operating income generated by the real estate
      to
      support the debt service, the financial resources and income level of the
      borrower, the borrower’s experience in owning or managing similar property, the
      marketability of the property and the Bank’s lending experience with the
      borrower. The Bank also typically receives a personal guarantee from the
      borrower. As of December 31, 2006, $5,399,000, or 0.6% of the Bank’s total loan
      portfolio, consisted of multi-family residential loans.










**Land
      and Residential Building Lots**





Land
      loans include loans to developers for the development of residential
      subdivisions and loans on unimproved lots primarily to individuals. At December
      31, 2006 the Bank had outstanding land and residential building lot loans
      totaling $96,639,000, or 10.1% of the Bank’s total loan portfolio. The largest
      of these loans is for $4,498,000, is secured by residentially zoned land in
      Ocean View, Delaware, and has performed in accordance with the terms of the
      debt
      instrument. Land development loans typically are short-term loans; the duration
      of these loans is typically not greater than three years. The interest rate
      on
      land loans is generally at least 1% or 2% over the prime rate. The loan-to-value
      ratio generally does not exceed 75%. Loans typically are made to customers
      of
      the Bank and developers and contractors with whom the Bank has had previous
      lending experience. In addition to the customary requirements for this type
      loan, the Bank may also require a satisfactory Phase I environmental study
      and
      feasibility study to determine the profit potential of the
      development.





**Consumer
      and Other Loans**





The
      Bank
      also offers other loans, primarily business and commercial loans. These are
      loans to businesses are not secured by real estate although equipment,
      securities, or other collateral may secure them. They constitute a relatively
      small part of the Bank’s business, and typically are offered to customers with
      long-standing relationships with the Bank. At December 31, 2006, $8,357,000,
      or
      0.9%, of the loan portfolio consisted of business and commercial loans. In
      addition, approximately 0.2% of the loan portfolio was in consumer
      loans.





**Loan
      Portfolio Cash Flows**





The
      following table sets forth the estimated maturity of the Bank’s loan portfolios
      by type of loan at December 31, 2006. The estimated maturity reflects
      contractual terms at December 31, 2006. Contractual principal repayments of
      loans do not necessarily reflect the actual term of the Bank’s loan portfolios.
      The average life of mortgage loans is substantially less than their contractual
      terms because of loan prepayments and because of enforcement of "due on sale"
      clauses. The average life of mortgage loans tends to increase, however, when
      current mortgage loan rates substantially exceed rates on existing mortgage
      loans.





Due
            
            Due
                afterWithin
            
            1
                through
            
            Due
                afterone
                year
            
            5
                years
            
            5
                years
            
            Total(dollars
                in thousands)One
                to four family residential
            
            $
            39,120
            
            $
            60,843
            
            $
            207,229
            
            $
            307,192Multifamily
            
            
            -
            
            
            3,041
            
            
            2,358
            
            
            5,399Commercial
                and industrial real estate
            
            
            7,577
            
            
            59,874
            
            
            128,265
            
            
            195,716Construction
                and land acquisitionand
                development loans
            
            
            283,871
            
            
            55,251
            
            
            -
            
            
            339,122Land
            
            
            32,108
            
            
            56,451
            
            
            8,080
            
            
            96,639Commercial,
                non-real estate
            
            
            4,705
            
            
            1,654
            
            
            1,998
            
            
            8,357Consumer
            
            
            219
            
            
            1,039
            
            
            279
            
            
            1,537Total
            
            $
            367,600
            
            $
            238,153
            
            $
            348,209
            
            $
            953,962


















The
      following table contains certain information as of December 31, 2006 relating
      to
      the loan portfolio of the Bank with the dollar amounts of loans due after one
      year that have fixed and floating rates. All loans are shown maturing based
      upon
      contractual maturities and include scheduled payments but not possible
      prepayments.





Fixed
            
            Floating
            
            Total(dollars
                in thousands)One
                to four family residential
            
            $
            131,387
            
            $
            136,686
            
            $
            268,073Multifamily
            
            
            2,425
            
            
            2,974
            
            
            5,399Commercial
                and industrial real estate
            
            
            75,961
            
            
            112,178
            
            
            188,139Construction
                and land acquisitionand
                development loans
            
            
            12,320
            
            
            42,930
            
            
            55,250Land
            
            
            39,217
            
            
            25,313
            
            
            64,530Commercial,
                non-real estate
            
            
            1,845
            
            
            1,807
            
            
            3,652Consumer
            
            
            1,319
            
            
            -
            
            
            1,319Total
            
            $
            264,474
            
            $
            321,888
            
            $
            586,362





**Loans
      to One Borrower**





Under
      regulatory guidelines, t he
      aggregate amount of loans that the Bank may make to one borrower is 15% of
      the
      Bank’s unimpaired capital and unimpaired surplus. The Bank’s largest single loan
      at December 31, 2006 was a $7,000,000 line of credit secured by assignments
      of
      notes, Deeds of Trust, pledged stock and certificates of deposit. The second
      largest loan is in the amount of $5,518,000 and is secured by four single-family
      dwellings in Potomac, MD, Silver Spring, MD, Washington, DC and Annapolis,
      MD in
      addition to a life insurance policy. The third largest loan is in the amount
      of
      $5,075,000 and is secured by commercial property located in Culpeper,
      VA.


**Origination
      and Purchase and Sale of Loans**





The
      Bank
      originates residential loans in conformity with standard underwriting criteria
      to assure maximum eligibility for possible resale in the secondary market.
      Although the Bank has authority to lend anywhere in the United States, they
      have
      confined their loan origination activities primarily to the states of Maryland,
      Virginia and Delaware.





Loan
      originations are developed from a number of sources, primarily from referrals
      from real estate brokers, builders, and existing and walk-in customers. The
      Bank
      also utilizes the services of loan brokers in its market area. Loan brokers
      are
      paid on a commission basis (generally 1% of the loan amount) for loans brokered
      to the Bank.





The
      Bank’s mortgage loan approval process is intended to assess the borrower's
      ability to repay the loan, the viability of the loan, and the adequacy of the
      value of the property that will secure the loan. The loan committee of the
      Bank
      can approve single residential and commercial loans up to $2 million, and loans
      that aggregate up to $5 million to one borrower. Single loans greater than
      $2
      million, or relationships greater than $5 million, up to $14,917,000 (the
      maximum amount of a loan to one borrower as of December 31, 2006) must also
      have
      Board of Director approval. The Bank utilizes independent qualified appraisers
      approved by the Board of Directors to appraise the properties securing its
      loans
      and requires title insurance or title opinions so as to insure that the Bank
      has
      a valid lien on the mortgaged real estate. The Bank requires borrowers to
      maintain fire and casualty insurance on its secured properties.





The
      procedure for approval of construction loans is the same as for residential
      mortgage loans, except that the appraiser evaluates the building plans,
      construction specifications, and estimates of construction costs. The Bank
      also
      evaluates the feasibility of the proposed construction project and the
      experience and track record of the developer. In addition, all construction
      loans generally require a commitment from a third-party lender or from the
      Bank
      for a permanent long-term loan to replace the construction loan upon completion
      of construction.







10






Consumer
      loans are underwritten on the basis of the borrower's credit history and an
      analysis of the borrower's income and expenses, ability to repay the loan,
      and
      the value of the collateral, if any.





Currently,
      it is the Bank’s policy to originate both fixed-rate and adjustable-rate loans.
      The Bank is currently active in the secondary market and sells the majority
      of
      its fixed-rate loan products.





**Interest
      Rates, Points and Fees**





The
      Bank
      realizes interest, point, and fee income from its lending activities. The Bank
      also realizes income from commitment fees for making commitments to originate
      loans, from prepayment and late charges, loan fees, application fees, and fees
      for other miscellaneous services.





The
      Bank
      accounts for loan origination fees in accordance with the Statement of Financial
      Accounting Standards (“SFAS”) on Accounting for Nonrefundable Fees and Costs
      Associated with Originating or Acquiring Loans ("SFAS No. 91") issued by the
      Financial Accounting Standards Board (the "FASB"). SFAS No. 91 prohibits
      the immediate recognition of loan origination fees as revenues and requires
      that
      such income (net of certain direct loan origination costs) for each loan be
      amortized, generally by the interest method, over the estimated life of the
      loan
      as an adjustment of yield. The Bank also realizes income from gains on sales
      of
      loans, and servicing released fees for loans sold with servicing
      released.





**Delinquency
      and Classified Assets**





**Delinquencies**





The
      Board
      of Directors reviews delinquencies on all loans monthly. The Bank’s collection
      procedures include sending a past due notice to the borrower on the 17th day
      of
      nonpayment, making telephone contact with the borrower between 20 and 30 days
      after nonpayment, and sending a letter after the 30th day of nonpayment. A
      notice of intent to foreclose is sent between 60 and 90 days after delinquency.
      When the borrower is contacted, the Bank attempts to obtain full payment of
      the
      past due amount. However, the Bank generally will seek to reach agreement with
      the borrower on a payment plan to avoid foreclosure.





The
      Bank
      categorizes its classified assets within four categories: Special Mention,
      Substandard, Doubtful and Loss. Special Mention loans are 60 days or more in
      arrears and include all borrowers who are in bankruptcy that have not missed
      any
      post-petition payments. The Bank reserves 5% on all Special Mention loans.
      Substandard loans are loans that are 90 days or more delinquent and are loans
      that have borrowers in bankruptcy that have missed a post-petition payment.
      The
      Bank reserves 15% of substandard loans. The Doubtful category consists of loans
      where the Bank expects a loss, but not a total loss. Various subjective factors
      are considered with the most important consideration being the estimated
      underlying value of the collateral. The Bank reserves 50% of the amount of
      Doubtful loans. Loans that are classified as “Loss” are fully
      reserved.





All
      loans
      are individually evaluated if they are deemed classified. The Bank also
      evaluates all delinquent loans, individually. The rest of the portfolio is
      evaluated as a group and a determination is made, periodically, concerning
      the
      inherent risks associated with particular types of loans and an allowance is
      assigned to those particular groups.





The
      Bank
      allocates reserves to its allowance for loan losses in two ways. Where the
      Bank
      has classified an asset it generally allocates the percentage of that asset
      under its classification system to a specific reserve if the asset is classified
      as Doubtful or Loss. In cases where loans are classified as Special Mention
      or
      Substandard the Bank usually does not allocate its allowance for loan loss
      reserves to a specific reserve. The Bank does not allocate its allowance for
      loan losses based upon the unclassified portion of its loan portfolio to
      specific loan reserves.







11





The
      following table sets forth information as to non-accrual loans. The Bank
      discontinues the accrual of interest on loans 90 days or more past due, at
      which
      time all previously accrued but uncollected interest is deducted from income.
      As
      of the most recent reported period, $416,000 would have been recorded for the
      year ended December 31, 2006 if the loans had been current in accordance with
      their original terms and had been outstanding throughout the year ended December
      31, 2006 or since their origination (if held for only part of the fiscal year).
      For the year ended December 31, 2006, $188,000 in interest income on such loans
      was actually included in net income.





At
                December 31,2006
            
            2005
            
            2004
            
            2003
            
            2002(dollars
                in thousands)Loans
                accounted for on a non-accrual basis:Mortgage
                loans:One-to-four
                family real estate
            
            $
            3,487
            
            $
            1,693
            
            $
            915
            
            $
            378
            
            $
            1,366Home
                equity lines of credit
            
            
            -
            
            
            -
            
            
            -
            
            
            50
            
            
            -Commercial
            
            
            98
            
            
            -
            
            
            -
            
            
            -
            
            
            253Land
            
            
            2,342
            
            
            -
            
            
            24
            
            
            24
            
            
            139Non-mortgage
                loans:Consumer
            
            
            -
            
            
            -
            
            
            -
            
            
            17
            
            
            -Commercial
                loans
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Total
                non-accrual loans
            
            $
            5,927
            
            $
            1,693
            
            $
            939
            
            $
            469
            
            $
            1,758Accruing
                loans greater than 90 days past due
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Foreclosed
                real-estate
            
            $
            970
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            224Total
                non-performing assets
            
            $
            6,897
            
            $
            1,693
            
            $
            939
            
            $
            469
            
            $
            1,982Total
                non-accrual loans to net loans
            
            
            0.7
            %
            
            0.2
            %
            
            0.1
            %
            
            0.1
            %
            
            0.4
            %Allowance
                for loan losses to total non-performing loans,including
                loans contractually past due 90 days or more
            
            
            152.3
            %
            
            443.3
            %
            
            632.1
            %
            
            1030.5
            %
            
            227.0
            %Total
                non-accrual and accruing loans greater than90
                days past due to total assets
            
            
            0.7
            %
            
            0.2
            %
            
            0.1
            %
            
            0.1
            %
            
            0.4
            %Total
                non-performing assets to total assets
            
            
            0.8
            %
            
            0.2
            %
            
            0.1
            %
            
            0.1
            %
            
            0.4
            %





**Classified
      Assets and Allowance for Loan Losses**





Federal
      regulations provide for the classification of loans and other assets, such
      as
      debt and equity securities, considered by the OTS to be of lesser quality as
      “substandard,” “doubtful” or “loss assets.” An asset is considered substandard
      if the paying capacity and net worth of the obligor or the collateral pledged,
      if any, inadequately protects it. Substandard assets include those characterized
      by the distinct possibility that the insured institution will sustain some
      loss
      if the deficiencies are not corrected. Assets classified as doubtful have all
      of
      the weaknesses inherent in those classified substandard with the added
      characteristic that the weaknesses present make collection or liquidation in
      full highly questionable and improbable, on the basis of currently existing
      facts, conditions, and values. Assets classified as loss assets are those
      considered uncollectible and of such little value that their continuance as
      assets without the establishment of a specific loss reserve is not warranted.
      Assets that do not currently expose the insured institution to a sufficient
      degree of risk to warrant classification in one of these categories but possess
      credit deficiencies or potential weakness are required to be designated special
      mention by management.




12





When
      an
      insured institution classifies problem assets as either substandard or doubtful,
      it is required to establish general allowance for losses in an amount deemed
      prudent by management. General allowances represent loss allowances which have
      been established to recognize the inherent risk associated with lending
      activities, but which, unlike specific allowances, have not been allocated
      to
      particular problem assets. When an insured institution classifies problem assets
      as loss assets, it is required either to establish a specific allowance for
      losses equal to the full amount of the asset so classified or to charge-off
      such
      amount. An institution’s determination as to the classification of its assets is
      subject to scrutiny by the OTS, which can require the establishment of
      additional general or specific loss allowances. The Bank reviews monthly the
      assets in its portfolio to determine whether any assets require classification
      in accordance with applicable regulations.





Total
      classified loans as of December 31, 2006 were $10,038,000. Allowance for loan
      losses as of December 31, 2006 was  $9,026,000,
      which is 0.9% of gross loans receivable and 152.3% of total non-performing
      loans.




[see
      table on following page]








13


The
      following table summarizes the allocation of the allowance for loan losses
      by
      loan type and the percent of loans in each category compared to total loans
      at
      the dates indicated:








2006
            
            2005
            
            2004
            
            2003
            
            2002Percentage
                of
            
            
            
            Percentage
                of
            
            
            
            Percentage
                of
            
            
            
            Percentage
                of
            
            
            
            Percentage
                ofLoans
                in each
            
            
            
            Loans
                in each
            
            
            
            Loans
                in each
            
            
            
            Loans
                in each
            
            
            
            Loans
                in eachAllowance
            
            Category
                to
            
            Allowance
            
            Category
                to
            
            Allowance
            
            Category
                to
            
            Allowance
            
            Category
                to
            
            Allowance
            
            Category
                toAmount
            
            Total
                Loans
            
            Amount
            
            Total
                Loans
            
            Amount
            
            Total
                Loans
            
            Amount
            
            Total
                Loans
            
            Amount
            
            Total
                Loans(dollars
                in thousands)Residential,
                one to four family
            $2,202
            
            32.41%
            
            $1,706
            
            29.74%
            
            $2,000
            
            30.20%
            
            $1,938
            
            36.20%
            
            $1,542
            
            36.58%Multifamily
            33
            
            0.57%
            
            67
            
            0.49%
            
            20
            
            0.34%
            
            21
            
            0.14%
            
            21
            
            0.27%Commercial
                and industrial real estate
            2,512
            
            20.45%
            
            1,965
            
            17.73%
            
            1,009
            
            16.17%
            
            1.154
            
            18.48%
            
            881
            
            19.33%Construction
                and land acquisition anddevelopment
                loans
            2,253
            
            35.44%
            
            2,684
            
            42.07%
            
            2,577
            
            43.42%
            
            1,173
            
            39.58%
            
            1,202
            
            38.77%Land
            1,731
            
            10.10%
            
            882
            
            8.78%
            
            251
            
            8.54%
            
            476
            
            4.25%
            
            300
            
            4.08%Business,
                commercial
            288
            
            0.87%
            
            193
            
            1.00%
            
            70
            
            1.18%
            
            59
            
            1.16%
            
            33
            
            0.79%Other
            7
            
            0.16%
            
            8
            
            0.19%
            
            8
            
            0.15%
            
            11
            
            0.19%
            
            12
            
            0.18%Total
            $9,026
            
            100.00%
            
            $7,505
            
            100.00%
            
            $5,935
            
            100.00%
            
            $4,832
            
            100.00%
            
            $3,991
            
            100.00%











14





The
      following table contains information with respect to Bancorp’s allowance for
      loan losses for the periods indicated:





At
                or for the Year EndedDecember
                312006
            
            2005
            
            2004
            
            2003
            
            2002(dollars
                in thousands)Average
                loans outstanding, net
            
            $
            819,038
            
            $
            738,028
            
            $
            600,030
            
            $
            466,512
            
            $
            384,537Total
                gross loans outstanding at end of period
            
            $
            953,962
            
            $
            927,993
            
            $
            790,254
            
            $
            608,222
            
            $
            493,083Total
                net loans outstanding at end of period
            
            $
            835,477
            
            $
            779,333
            
            $
            656,967
            
            $
            506,026
            
            $
            418,825Allowance
                balance at beginning of period
            
            $
            7,505
            
            $
            5,935
            
            $
            4,832
            
            $
            3,991
            
            $
            3,353Provision
                for loan losses
            
            
            1,561
            
            
            1,570
            
            
            1,200
            
            
            900
            
            
            670Actual
                charge-offs1-4
                family residential real estate
            
            
            -
            
            
            -
            
            
            97
            
            
            25
            
            
            -Other
            
            
            40
            
            
            -
            
            
            -
            
            
            34
            
            
            32Total
                charge-offs
            
            
            40
            
            
            -
            
            
            97
            
            
            59
            
            
            32RecoveriesTotal
                recoveries
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Net
                charge offs
            
            
            -
            
            
            -
            
            
            97
            
            
            59
            
            
            32Allowance
                balance at end of period
            
            $
            9,026
            
            $
            7,505
            
            $
            5,935
            
            $
            4,832
            
            $
            3,991Net
                charge offs as a percent of average loans
            
            
            0.00
            %
            
            0.00
            %
            
            0.02
            %
            
            0.01
            %
            
            0.01
            %Allowance
                for loan losses to total gross loans at end of period
            
            
            0.95
            %
            
            0.81
            %
            
            0.75
            %
            
            0.79
            %
            
            0.81
            %Allowance
                for loan losses to net loans at end of period
            
            
            1.08
            %
            
            0.96
            %
            
            0.90
            %
            
            0.95
            %
            
            0.95
            %








**Investment
      Activities**





Federal
      thrift institutions, such as the Bank, have authority to invest in various
      types
      of liquid assets, including United States Treasury obliga-tions and securities
      of various federal agencies, certificates of deposit at insured banks, bankers'
      acceptances and federal funds. As a member of the FHLB System, the Bank must
      maintain minimum levels of liquid assets specified by the OTS, which vary from
      time to time. Subject to various regulatory restrictions, federal thrift
      institutions may also invest a portion of their assets in certain commercial
      paper, corporate debt securities and mutual funds whose assets conform to the
      investments that a federal thrift institution is authorized to make directly.





The
      carrying amounts of the Bank’s investment securities held to maturity, as of the
      dates indicated are presented in the following table:




At
                    December 31,2006
                
                2005
                
                2004(dollars
                    in thousands)FHLB
                    Notes
                
                $
                5,000
                
                $
                5,000
                
                $
                5,000Mortgage-backed
                    securities
                
                
                2,271
                
                
                3,290
                
                
                4,955Total
                    Investment Securities Held to Maturity
                
                $
                7,271
                
                $
                8,290
                
                $
                9,955





15








Investment
      Scheduled Maturity Table





As
      of
      December 31, 2006







More
                    than One to
                
                More
                    than Five toOne
                    Year or Less
                
                Five
                    Years
                
                Ten
                    Years
                
                More
                    than Ten Years
                
                Total
                    Investment SecuritiesCarrying
                Average
                
                Carrying
                Average
                
                Carrying
                Average
                
                Carrying
                Average
                
                Carrying
                Average
                FairAmount
                Yield
                
                Amount
                Yield
                
                Amount
                Yield
                
                Amount
                Yield
                
                Amount
                Yield
                Value(dollars
                    in thousands)FHLB
                    Notes
                4,000
                2.58%
                
                -
                -
                
                $1,000
                5.05%
                
                -
                -
                
                $5,000
                3.07%
                $4,925Mortgage-backed
                    securities
                796
                4.50%
                
                -
                -
                
                -
                -
                
                1,475
                5.47%
                
                2,271
                5.13%
                2,192Total
                $4,796
                2.90%
                
                $-
                -
                
                $1,000
                5.05%
                
                $1,475
                5.47%
                
                $7,271
                3.62%
                $7,117












16


**Deposits**





Deposits
      are attracted principally from within the Bank’s primary market areas through
      the offering of a variety of deposit instruments, including passbook and
      statement accounts and certificates of deposit ranging in terms from three
      months to five years. Deposit account terms vary, principally on the basis
      of
      the minimum balance required, the time periods the funds must remain on deposit
      and the interest rate. The Bank also offers individual retirement
      accounts.





The
      Bank’s policies are designed primarily to attract deposits from local residents
      rather than to solicit deposits from areas outside their primary markets.
      Interest rates paid, maturity terms, service fees and withdrawal penalties
      are
      established by the Bank on a periodic basis. Determination of rates and terms
      are predicated upon funds acquisition and liquidity requirements, rates paid
      by
      competitors, growth goals and federal regulations.





Deposits
      in the Bank as of December 31, 2006, 2005 and 2004 consisted of savings programs
      described below:





2006
            
            2005
            
            2004(dollars
                in thousands)NOW
                accounts
            
            $
            9,314
            
            $
            7,683
            
            $
            4,872Money
                market accounts
            
            
            89,120
            
            
            99,911
            
            
            131,014Passbooks
            
            
            18,526
            
            
            17,505
            
            
            18,198Certificates
                of deposit
            
            
            490,865
            
            
            445,592
            
            
            356,447Non-interest
                bearing accounts
            
            
            18,699
            
            
            24,202
            
            
            16,882Total
                deposits
            
            $
            626,524
            
            $
            594,893
            
            $
            527,413





The
      following table contains information pertaining to the certificates of deposit
      held by the Bank in excess of $100,000 as of December 31, 2006.





Jumbo
                Certificateof
                DepositsTime
                Remaining Until Maturity
            
            (dollars
                in thousands)Less
                than three months
            
            $52,4523
                months to 6 months
            
            38,5676
                months to 12 months
            
            67,112Greater
                than 12 months
            
            42,464Total
            
            $200,595






































17




**Liquidity
      and Asset/Liability Management**





Two
      major
      objectives of asset and liability management are to maintain adequate liquidity
      and to control the interest sensitivity of the balance sheet.





Liquidity
      is the measure of a company’s ability to maintain sufficient cash flow to fund
      operations and to meet financial obligations to depositors and borrowers.
      Liquidity is provided by the ability to attract and retain deposits and by
      principal and interest payments on loans and maturing securities in the
      investment portfolio. A strong core deposit base, supplemented by other deposits
      of varying maturities and rates, contributes to the Bank’s
      liquidity.





Funds
      available through short-term borrowings and asset maturities are considered
      adequate to meet all current needs, and management is continually monitoring
      the
      Bank’s liquidity position to meet projected needs.





Interest
      rate sensitivity is maintaining the ability to reprice interest earning assets
      and interest bearing liabilities in relationship to changes in the general
      level
      of interest rates. Management attributes interest rate sensitivity to a steady
      net interest margin through all phases of interest rate cycles. Management
      attempts to make the necessary adjustments to constrain adverse swings in net
      interest income resulting from interest rate movements through gap analysis
      and
      income simulation modeling techniques.





**Short
      Term Borrowings**





The
      Bank
      has an available line of credit, secured by various loans in its portfolio,
      in
      the amount of thirty percent (30%) of its total assets, with the FHLB-Atlanta.
      As of December 31, 2006, the total available line of credit with the
      FHLB-Atlanta for short term and long-term borrowings was $273,575,000. The
      Bank,
      from time to time, utilizes the line of credit when interest rates are more
      favorable then obtaining deposits from the public. The following table sets
      forth short-term borrowings with the FHLB-Atlanta, with original maturities
      of
      one year or less.





Years
                ended December 31,2006
            
            2005
            
            2004(dollars
                in thousands)Short
                term borrowings and notes payableAverage
                balance outstanding during the period
            
            $
            8,250
            
            $
            25,833
            
            $
            15,567Maximum
                amount outstanding at any month-end duringthe
                period
            
            
            26,000
            
            
            41,000
            
            
            41,000Weighted
                Average interest rate during the period
            
            
            5.31
            %
            
            3.30
            %
            
            1.67
            %Total
                short term borrowings at period end
            
            
            18,000
            
            
            26,000
            
            
            -Weighted
                average interest rate at period end
            
            
            5.41
            %
            
            3.33
            %
            
            0.00
            %









18


**Employees**





As
      of
      December 31, 2006, Bancorp and its subsidiaries had approximately 121 full-time
      equivalent employees. Bancorp’s employees are not represented by any collective
      bargaining group, and management considers its relations with its employees
      to
      be excellent.





**Severn
      Capital**





The
      Bank
      formed Severn Capital in 1997 for the purpose of acquiring, holding and managing
      mortgage loans. Severn Capital had elected to be subject to tax as a real estate
      investment trust under the Internal Revenue Code of 1986, as amended, and
      regulations promulgated thereunder (the “Code”). The Bank owned all of the
      common stock of Severn Capital and administered the day-to-day operations of
      Severn Capital for a fee. There were 200,002 shares of preferred stock of Severn
      Capital outstanding, which were held by third parties and which were reflected
      as minority interest in the consolidated financial statements. Dividends on
      the
      preferred stock were payable quarterly, in an amount equal to $1.80 per annum
      per preferred share. On January 31, 2005, the Bank liquidated Severn Capital
      and
      redeemed the shares at $20 per share.





**Hyatt
      Commercial**





Bancorp
      acquired Hyatt Commercial, a real estate brokerage and property management
      company, in June 2001. Hyatt Commercial is a real estate brokerage company
      specializing in commercial real estate sales, leasing and property management.
      It owns property at 1919 and 1919A West Street, which is leased to unrelated
      parties. Hyatt Commercial has entered into an agreement to sell these
      properties, and is expected to settle on them in the first quarter of
      2007.





**Crownsville
      Development Corporation**





Crownsville,
      which is doing business as AEG, is a subsidiary of SBI and is engaged in the
      business of acquiring real estate for investment and syndication purposes.
      In
      2006, AEG brokered the acquisition of three properties in Delaware and
      facilitated the syndication of the properties.





**SBI
      Mortgage Company**





SBI
      is a
      subsidiary of Bancorp that has engaged in the origination of mortgages not
      suitable for the Bank. It owns subsidiary companies that have or are negotiating
      to purchase real estate for investment purposes. As of December 31, 2006, SBI
      had $1,685,000 in outstanding mortgage loans and it had $408,000 invested in
      subsidiaries, which funds were held in cash, pending potential acquisition
      of
      investment real estate.





**HS
      West, LLC**





HS
      West, LLC
      (“HS”) is a subsidiary of the Bank, and is constructing a building in Annapolis,
      Maryland that effective January 2007 will serve as Bancorp’s and the Bank’s
      administrative headquarters. A branch office of the Bank is included. As of
      December 31, 2006, HS West, LLC has incurred approximately  $26,312,000
      of costs, which are included in land and construction in progress. The total
      cost, which includes build-out costs on leased space, is expected to be
      approximately  $28,000,000
      with completion mid 2007. HS has entered into agreements to lease all the
      remaining space in the building not occupied by the Bank and
      Bancorp.





**Homeowners
      Title and Escrow Corporation**





Homeowners
      Title and Escrow Corporation, is a subsidiary of the Bank, and is engaged in
      the
      business of conducting loan settlements for the Bank.







19






**Regulation**




***Competition***




The
      financial services industry in the Bank’s market area is highly competitive,
      including competition from commercial banks, savings banks, credit unions,
      finance companies and non-bank providers of financial services. Several of
      the
      Bank’s competitors have legal lending limits that exceed that of the Bank’s, as
      well as funding sources in the capital markets that exceeds the Bank’s
      availability. The increased competition has resulted from a changing legal
      and
      regulatory climate, as well as from the economic climate.





***General***





Savings
      and
      loan holding companies and savings associations are extensively regulated under
      both federal and state law. This regulation is intended primarily for the
      protection of depositors and the DIF and not for the benefit of stockholders
      of
      Bancorp. The following information describes certain aspects of that regulation
      applicable to Bancorp and the Bank, and does not purport to be complete. The
      discussion is qualified in its entirety by reference to all particular statutory
      or regulatory provisions.





***Regulation
      of Bancorp***




***General*** .
      Bancorp
      is a unitary savings and loan holding company subject to regulatory oversight
      by
      the OTS. As such, Bancorp is required to register and file reports with the
      OTS
      and is subject to regulation and examination by the OTS. In addition, the OTS
      has enforcement authority over Bancorp and its subsidiaries, which also permits
      the OTS to restrict or prohibit activities that are determined to be a serious
      risk to the subsidiary savings association.





***Activities
      Restriction Test.*** As a
      unitary savings and loan holding company, Bancorp generally is not subject
      to
      activity restrictions, provided the Bank satisfies the Qualified Thrift Lender
      (“QTL”) test or meets the definition of domestic building and loan association
      pursuant to the Code. Bancorp presently intends to continue to operate as a
      unitary savings and loan holding company. Recent legislation terminated the
      “unitary thrift holding company exemption” for all companies that apply to
      acquire savings associations after May 4, 1999. Since Bancorp is grandfathered,
      its unitary holding company powers and authorities were not affected. See
“Regulation of Bancorp - Financial Modernization Legislation.” However, if
      Bancorp acquires control of another savings association as a separate
      subsidiary, it would become a multiple savings and loan holding company, and
      the
      activities of Bancorp and any of its subsidiaries (other than the Bank or any
      other DIF-insured savings association) would become subject to restrictions
      applicable to bank holding companies unless such other associations each also
      qualify as a QTL or domestic building and loan association and were acquired
      in
      a supervisory acquisition. Furthermore, if Bancorp were in the future to sell
      control of the Bank to any other company, such company would not succeed to
      Bancorp grandfathered status under the GLB (as defined below in “Regulation of
      Bancorp - Financial Services Modernization Legislation”) and would be subject to
      the same business activity restrictions as any other bank holding company.
      See
“- Regulation of the Bank - Qualified Thrift Lender Test.”





***Restrictions
      on Acquisitions*** .
      Bancorp
      must obtain approval from the OTS before acquiring control of any other
      DIF-insured association. Such acquisitions are generally prohibited if they
      result in a multiple savings and loan holding company controlling savings
      associations in more than one state. However, such interstate acquisitions
      are
      permitted based on specific state authorization or in a supervisory acquisition
      of a failing savings association.





Federal
      law generally provides that no “person,” acting directly or indirectly or
      through or in concert with one or more other persons, may acquire “control,” as
      that term is defined in OTS regulations, of a federally insured savings
      association without giving at least 60 days written notice to the OTS and
      providing the OTS an opportunity to disapprove the proposed acquisition. In
      addition, no company may acquire control of such an institution without prior
      OTS approval. These provisions also prohibit, among other things, any director
      or officer of a savings and loan holding company, or any individual who owns
      or
      controls more than 25% of the voting shares of a savings and loan holding
      company, from acquiring control of any savings association not a subsidiary
      of
      the savings and loan holding company, unless the acquisition is approved by
      the
      OTS. For additional restrictions on the acquisition of a unitary thrift holding
      company, see “Regulation of Bancorp - Financial Services Modernization
      Legislation.” Certain individuals, including Alan J. Hyatt, Louis Hyatt, and
      Melvin Hyatt, and their respective spouses (“Applicants”), filed an Application
      for Notice of Change In Control (“Notice”) in April 2001 pursuant to 12 CFR
      Section 574.3(b). The Notice called for the Applicants to acquire up to 32.32%
      of Bancorp’s issued and outstanding shares of stock of Bancorp by April 16,
      2002. The OTS approved requests by the Applicants to extend the time to
      consummate such acquisition of shares to January 4, 2008. The Applicants
      currently own approximately 29.25% of  the
      total
      outstanding shares of Bancorp as of December 31, 2006.








20





***Federal
        Securities Law*** .
        Bancorp’s securities are currently registered with the Securities and Exchange
        Commission under the Securities Exchange Act of 1934, as amended. As such,
        Bancorp is subject to the information, proxy solicitation, insider trading,
        and
        other requirements and restrictions of the Securities Exchange Act of
        1934.





***The
      Sarbanes-Oxley Act of 2002*** . On
      July 30, 2002, the Sarbanes-Oxley Act of 2002 was enacted. The
      Sarbanes-Oxley Act represents a comprehensive revision of laws affecting
      corporate governance, accounting obligations and corporate reporting. The
      Sarbanes-Oxley Act is applicable to all companies with equity securities
      registered or that file reports under the Securities Exchange Act of 1934.
      In
      particular, the Sarbanes-Oxley Act established: (i) new requirements for
      audit committees, including independence, expertise and responsibilities;
      (ii) additional responsibilities regarding financial statements for the
      Chief Executive Officer and Chief Financial Officer of the reporting company;
      (iii) new standards for auditors and regulation of audits;
      (iv) increased disclosure and reporting obligations for the reporting
      company and its directors and executive officers; and (v) new and increased
      civil and criminal penalties for violations of the securities laws. Many of
      the
      provisions were effective immediately while other provisions became effective
      over a period of time and are subject to rulemaking by the SEC. Because
      Bancorp’s common stock is registered with the SEC, it is currently subject to
      the Sarbanes-Oxley Act.





Throughout
      2002 and 2003, the SEC and Nasdaq Stock Market issued new regulations affecting
      Bancorp’s corporate governance and heightening its disclosure requirements.
      Among the many new changes are enhanced proxy statement disclosures on corporate
      governance, stricter independence requirements for the Board of Directors and
      its committees, and posting of various SEC reports on our website. The full
      impact of the Sarbanes-Oxley Act is still uncertain and evolving, however the
      new legislation and implementing regulations have resulted in increased costs
      of
      compliance, including certain outside professional costs.





We
      cannot
      predict what legislation might be enacted or what regulations might be adopted,
      or if enacted or adopted, the effect thereof on our operations.





***USA
      Patriot Act of 2001*** . On
      October 26, 2001, the Uniting and Strengthening America by Providing
      Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001,
      or
      the USA Patriot Act of 2001 was enacted. This act contains the International
      Money Laundering Abatement and Financial Anti-Terrorism Act of 2001, which
      sets
      forth anti-money laundering measures affecting insured depository institutions,
      broker-dealers and other financial institutions. The Act requires U.S. financial
      institutions to adopt new policies and procedures to combat money laundering
      and
      grants the Secretary of the Treasury broad authority to establish regulations
      and to impose requirements and restrictions on the operations of financial
      institutions.





***Financial
      Services Modernization Legislation*** .
      In
      November 1999, the Gramm-Leach-Bliley Act of 1999 (the “GLB”) was enacted. As a
      result of GLB new opportunities became available to financial institution
      holding companies as it removed the restrictions that resulted from a regulatory
      framework that had its origin in the Great Depression of the 1930s. In addition,
      the GLB also contains provisions that expressly preempt any state law
      restricting the establishment of financial affiliations, primarily related
      to
      insurance.





The
      general effect of GLB is to permit banks, other depository institutions,
      insurance companies and securities firms to enter into combinations that result
      in a single financial services organization to offer customers a wider array
      of
      financial services and products, through a new entity known as a “financial
      holding company.” “Financial activities” is broadly defined to include not only
      banking, insurance and securities activities, but other activities incidental
      to
      such financial activities or complementary activities that do not pose a
      substantial risk to the safety and soundness of depository institutions or
      the
      financial system generally.






21






The
      GLB
      also permits national banks to engage in expanded activities through the
      formation of financial subsidiaries. A national bank may have a subsidiary
      engaged in any activity authorized for national banks directly or any financial
      activity, except for insurance underwriting, insurance investments, real estate
      investment or development, or merchant banking, which may only be conducted
      through a subsidiary of a financial holding company. Financial activities
      include all activities permitted under new sections of the Bank Holding Company
      Act or permitted by regulation.





To
      the
      extent that the GLB permits banks, securities firms and insurance companies
      to
      affiliate, the financial services industry may experience further consolidation.
      The GLB is intended to grant to community banks certain powers as a matter
      of
      right that larger institutions have accumulated on an ad hoc basis and which
      unitary savings and loan holding companies already possess. Nevertheless, the
      GLB may have the result of increasing the amount of competition that Bancorp
      and
      the Bank faces from larger institutions and other types of companies offering
      financial products, many of which may have substantially more financial
      resources than Bancorp and the Bank.





***Maryland
      Corporation Law*** .
      Bancorp
      is incorporated under the laws of the State of Maryland, and is therefore
      subject to regulation by the state of Maryland. The rights of Bancorp’s
      stockholders are governed by the Maryland General Corporation Law.







***Regulation
      of the Bank***




***General*** .
      As a
      federally chartered, DIF-insured savings association, the Bank is subject to
      extensive regulation by the OTS and the FDIC. Lending activities and other
      investments of the Bank must comply with various statutory and regulatory
      requirements. The Bank is also subject to certain reserve requirements
      promulgated by the FRB.





The
      OTS,
      in conjunction with the FDIC, regularly examines the Bank and prepares reports
      for the consideration of the Bank’s Board of Directors on any deficiencies found
      in the operations of the Bank. The relationship between the Bank and depositors
      and borrowers is also regulated by federal and state laws, especially in such
      matters as the ownership of savings accounts and the form and content of
      mortgage documents utilized by the Bank.





The
      Bank
      must file reports with the OTS and the FDIC concerning its activities and
      financial condition, in addition to obtaining regulatory approvals prior to
      entering into certain transactions such as mergers with or acquisitions of
      other
      financial institutions. This regulation and supervision establishes a
      comprehensive framework of activities in which an institution can engage and
      is
      intended primarily for the protection of the DIF and depositors. The regulatory
      structure also gives the regulatory authorities extensive discretion in
      connection with their supervisory and enforcement activities and examination
      policies, including policies with respect to the classification of assets and
      the establishment of adequate loan loss reserves for regulatory purposes. Any
      change in such regulations, whether by the OTS, the FDIC or the Congress could
      have a material adverse impact on Bancorp, the Bank, and their
      operations.





***Regulatory
      Capital Requirements*** .
      The
      federal banking agencies have adopted risk-based minimum capital guidelines
      intended to provide a measure of capital that reflects the degree of risk
      associated with a banking organization’s operations for both transactions
      reported on the balance sheet as assets and transactions which are recorded
      as
      off balance sheet items. Under these guidelines, nominal dollar amounts of
      assets and credit equivalent amounts of off balance sheet items are multiplied
      by one of several risk adjustment percentages, which range from 0% for assets
      with low credit risk federal banking agencies, to 100% for assets with
      relatively high credit risk.





The
      risk-based capital ratio is determined by classifying assets and certain
      off-balance sheet financial instruments into weighted categories, with higher
      levels of capital being required for those categories perceived as representing
      greater risk. Under the capital guidelines, a banking organization’s total
      capital is divided into tiers. “Tier I capital” consists of (1) common equity,
      (2) qualifying noncumulative perpetual preferred stock, (3) a limited amount
      of
      qualifying cumulative perpetual preferred stock and (4) minority interests
      in
      the equity accounts of consolidated subsidiaries (including trust-preferred
      securities), less goodwill and certain other intangible assets. Not more than
      25% of qualifying Tier I capital may consist of trust-preferred securities.
      “Tier II capital” consists of hybrid capital instruments, perpetual debt,
      mandatory convertible debt securities, a limited amount of subordinated debt,
      preferred stock that does not qualify as Tier I capital, a limited amount of
      the
      allowance for loan and lease losses and a limited amount of unrealized holding
      gains on equity securities. “Tier III capital” consists of qualifying unsecured
      subordinated debt. The sum of Tier II and Tier III capital may not exceed the
      amount of Tier I capital.





22







In
      addition,
      the guidelines require a minimum ratio of qualifying total capital to
      risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to
      risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal
      banking regulators require banking organizations to maintain a minimum amount
      of
      Tier 1 capital to total assets, referred to as the leverage ratio. For a banking
      organization rated in the highest of the five categories used by regulators
      to
      rate banking organizations, the minimum leverage ratio of Tier 1 capital to
      total assets must be 3%. In addition to these uniform risk-based capital
      guidelines and leverage ratios that apply across the industry, the regulators
      have the discretion to set individual minimum capital requirements for specific
      institutions at rates significantly above the minimum guidelines and ratios.
      The
      Bank is not subject to any such individual minimum regulatory capital
      requirement.





As
      shown
      below, the Bank’s regulatory capital exceeded all minimum regulatory capital
      requirements applicable to it as of December 31, 2006.




Actual
              
              Required
                  For Capital
                Adequacy
                  Purposes
              
              Required
                  To Be Well Capitalized Under Prompt Corrective Action
                  ProvisionsAmount
              
              %
              
              Amount
              
              %
              
              Amount
              
              %(dollars
                  in thousands)December
                  31, 2006Tangible
                  (1)
              
              $
              99,445
              
              
              11.0
              %
              $
              13,513
              
              
              1.50
              %
              
              N/A
              
              
              N/ATier
                  I capital (2)
              
              
              99,445
              
              
              13.1
              %
              
              N/A
              
              
              N/A
              
              $
              45,582
              
              
              6.00
              %Core
                  (1)
              
              
              99,445
              
              
              11.0
              %
              
              36,034
              
              
              4.00
              %
              
              45,043
              
              
              5.00
              %Total
                  (2)
              
              
              108,452
              
              
              14.3
              %
              
              60,776
              
              
              8.00
              %
              
              75,971
              
              
              10.00
              %December
                  31, 2005Tangible
                  (1)
              
              $
              86,354
              
              
              10.3
              %
              $
              12,619
              
              
              1.50
              %
              
              N/A
              
              
              N/ATier
                  I capital (2)
              
              
              86,354
              
              
              12.2
              %
              
              N/A
              
              
              N/A
              
              $
              42,395
              
              
              6.00
              %Core
                  (1)
              
              
              86,354
              
              
              10.3
              %
              
              33,651
              
              
              4.00
              %
              
              42,064
              
              
              5.00
              %Total
                  (2)
              
              
              93,851
              
              
              13.3
              %
              
              56,527
              
              
              8.00
              %
              
              70,659
              
              
              10.00
              %


____________


(1)
      To
      adjusted total assets.


(2)
      To
      risk-weighted assets.







The
      Home
      Owners’ Loan Act (“HOLA”) permits savings associations not in compliance with
      the OTS capital standards to seek an exemption from certain penalties or
      sanctions for noncompliance. Such an exemption will be granted only if certain
      strict requirements are met, and must be denied under certain circumstances.
      If
      an exemption is granted by the OTS, the savings association still may be subject
      to enforcement actions for other violations of law or unsafe or unsound
      practices or conditions.





***Safety
      and Soundness Standards*** .
      Pursuant to the requirements of the Federal Deposit Insurance Corporation
      Improvement Act, as amended by the Riegle Community Development and Regulatory
      Improvement Act of 1994, each federal banking agency, including the OTS, has
      adopted guidelines establishing general standards relating to internal controls,
      information and internal audit systems, loan documentation, credit underwriting,
      interest rate exposure, asset growth, asset quality, earnings and compensation,
      fees and benefits. In general, the guidelines require, among other things,
      appropriate systems and practices to identify and manage the risks and exposures
      specified in the guidelines. The guidelines prohibit excessive compensation
      as
      an unsafe and unsound practice and describe compensation as excessive when
      the
      amounts paid are unreasonable or disproportionate to the services performed
      by
      an executive officer, employee, director, or principal stockholder.




23




In
      addition, the OTS adopted regulations to require a savings bank that is given
      notice by the OTS that it is not satisfying any such safety and soundness
      standards to submit a compliance plan to the OTS. If, after being so notified,
      a
      savings bank fails to submit an acceptable compliance plan or fails in any
      material respect to implement an accepted compliance plan, the OTS may issue
      an
      order directing corrective and other actions of the types to which a
      significantly undercapitalized institution is subject under the “prompt
      corrective action” provisions of the Federal Deposit Insurance Corporation
      Improvement Act. If a savings bank fails to comply with such an order, the
      OTS
      may seek to enforce the order in judicial proceedings and to impose civil
      monetary penalties.





***Prompt
      Corrective Action*** .
      The
      prompt corrective action regulation of the OTS, requires certain mandatory
      actions and authorizes certain other discretionary actions to be taken by the
      OTS against a savings association that falls within certain undercapitalized
      capital categories specified in the regulation.





The
      regulation establishes five categories of capital classification:


·
            “well
                capitalized”;


·
            “adequately
                capitalized”;


·
            “undercapitalized”;


·
            “significantly
                undercapitalized”; and


·
            “critically
                undercapitalized”.





Under
      the
      regulation, the risk-based capital, leverage capital, and tangible capital
      ratios are used to determine an institution’s capital classification. At
      December 31, 2006, the Bank met the capital requirements of a “well capitalized”
institution under applicable OTS regulations.





In
      general, the prompt corrective action regulation prohibits an insured depository
      institution from declaring any dividends, making any other capital distribution,
      or paying a management fee to a controlling person if, following the
      distribution or payment, the institution would be within any of the three
      undercapitalized categories. In addition, adequately capitalized institutions
      may accept brokered deposits only with a waiver from the FDIC and are subject
      to
      restrictions on the interest rates that can be paid on such deposits.
      Undercapitalized institutions may not accept, renew, or roll-over brokered
      deposits.





If
      the
      OTS determines that an institution is in an unsafe or unsound condition, or
      if
      the institution is deemed to be engaging in an unsafe and unsound practice,
      the
      OTS may, if the institution is well capitalized, reclassify it as adequately
      capitalized; if the institution is adequately capitalized but not well
      capitalized, require it to comply with restrictions applicable to
      undercapitalized institutions; and, if the institution is undercapitalized,
      require it to comply with certain restrictions applicable to significantly
      undercapitalized institutions. Finally, pursuant to an interagency agreement,
      the FDIC can examine any institution that has a substandard regulatory
      examination score or is considered undercapitalized - without the express
      permission of the institution’s primary regulator.





***Premiums
      for Deposit Insurance*** .
      Until
      recently, the deposits in the Bank were insured by the Savings Association
      Insurance Fund (“SAIF”), administered by the FDIC. On February 8, 2006 the
      Federal Deposit Insurance Reform Act of 2005 was enacted, which among other
      things, merged the SAIF with the Bank Insurance Fund (“BIF”), creating the DIF,
      effective as of March 31, 2006.




The
      FDIC
      has also adopted a new risk-based premium system that provides for quarterly
      assessments based on an insured institution's ranking in one of four risk
      categories that are based upon supervisory and capital evaluations. The FDIC’s
      regulations establish four risk categories. Risk Category I, for
      well-capitalized institutions that are financially sound with only a few minor
      weaknesses, includes about 95% of FDIC-insured institutions based on FDIC
      estimates. Bancorp is within Risk Category I. Risk Categories II, III and IV
      present progressively greater risks to the DIF. Effective January 1, 2007,
      Risk
      Category I institutions pay quarterly assessments for deposit insurance at
      annual rates of 5 to 7 basis points (i.e., $0.05 to $0.07 per $100 of assessable
      deposits). The rates for Risk Categories II, III and IV are 10, 28 and 43 basis
      points, respectively. With advance notice to insured institutions, rates are
      subject to change. Within Risk Category I, the precise rate for an individual
      institution with less than $10 billion in assets is generally determined by
      a
      formula using CAMELS ratings, which are bank ratings assigned in examinations,
      and financial ratios. A different method applies for larger institutions. The
      rate for an individual institution is applied to its assessment base, consisting
      generally of its deposit liabilities subject to certain adjustments. An
      institution insured by the FDIC on December 31, 1996 which had previously paid
      assessments (or its successor) is eligible for certain credit against deposit
      insurance assessments. Any increase in assessments or the assessment rate could
      have a material adverse effect on Bancorp’s earning, depending on the amount of
      the increase.





24







The
      FDIC is
      authorized to terminate a depository institution’s deposit insurance upon a
      finding by the FDIC that the institution’s financial condition is unsafe or
      unsound or that the institution has engaged in unsafe or unsound practices
      or
      has violated any applicable rule, regulation, order or condition enacted or
      imposed by the institution’s regulatory agency. The termination of deposit
      insurance for one or more of Bancorp’s subsidiary depository institutions could
      have a material adverse effect on Bancorp’s earnings, depending on the
      collective size of the particular institutions involved.





All
      FDIC-insured depository institutions must pay an annual assessment to provide
      funds for the payment of interest on bonds issued by the Financing Corporation,
      a federal corporation chartered under the authority of the Federal Housing
      Finance Board. The bonds, commonly referred to as Financing Corporation (“FICO”)
      bonds, were issued to capitalize the Federal Savings and Loan Insurance
      Corporation. The annual FICO assessment rate as of the first quarter of 2007
      is
      1.22 basis points (i.e. $0.0122 for every $100 of assessable deposits). The
      FICO
      assessments are adjusted quarterly to reflect changes in the assessment bases
      of
      the FDIC’s insurance funds and do not vary depending on a depository
      institution’s capitalization or supervisory evaluations.





***Privacy*** .
      Federal
      banking rules limit the ability of banks and other financial institutions to
      disclose non-public information about consumers to nonaffiliated third parties.
      Pursuant to these rules, financial institutions must provide:




·
            initial
                notices to customers about their privacy policies, describing the
                conditions under which they may disclose nonpublic personal information
                to
                nonaffiliated third parties and affiliates;


·
            annual
                notices of their privacy policies to current customers;
                and


·
            a
                reasonable method for customers to “opt out” of disclosures to
                nonaffiliated third parties.





These
      privacy provisions affect how consumer information is transmitted through
      diversified financial companies and conveyed to outside vendors. Since GLB’s
      enactment, a number of states have implemented their own versions of privacy
      laws. The Bank has implemented its privacy policies in accordance with the
      law.





***Interagency
      Guidance on Response Programs for Unauthorized Access to Customer Information
      and Customer Notice*** .
      On
      March 30, 2005, the federal bank and thrift regulatory agencies jointly issued
      a
      guidance that required financial institutions to develop programs to respond
      to
      incidents of unauthorized access to customer information, including procedures
      for notifying customers under certain circumstances. The proposed
      guidance:





·
            interprets
                section 501(b) of the GLB Act and previously issued interagency customer
                information security guidelines that require financial institutions
                to
                implement information security programs designed to protect their
                customer’s information; and


·
            describe
                the components of a response program and sets a standard for providing
                notice to customers affected by unauthorized access to or use of
                customer
                information that could result in substantial harm or inconvenience
                to
                those customers, thereby reducing the risk of losses due to fraud
                or
                identify theft.


·
            Among
                other security measures, requires financial institutions to notify
                law
                enforcement authorities and their primary federal regulator when
                such
                institutions become aware of an incident involving unauthorized access
                to
                or use of sensitive customer information





The
      Bank
      is required to and intends to comply with the guidance as it is interpreted
      and
      applied by the OTS.





25







***Predatory
      Lending*** .
      The
      term “predatory lending” much like the terms “safety and soundness” and “unfair
      deceptive practices,” is far-reaching and covers a potentially broad range of
      behavior. As such, it does not lend itself to a concise or a comprehensive
      definition. But, typically predatory lending involves at least one, and perhaps
      all three, of the following elements:





·
            making
                unaffordable loans based on the assets of the borrower rather than
                on the
                borrower’s ability to repay an obligation (“asset-based lending”)


·
            inducing
                a borrower to refinance a loan repeatedly in order to charge high
                points
                and fees each time the loan is refinanced (“loan flipping”)


·
            engaging
                in fraud or deception to conceal the true nature of the loan obligation
                from an unsuspecting or unsophisticated borrower.





On
      October 1, 2002, FRB regulations aimed at curbing such lending became effective.
      The rule significantly widens the pool of high-cost home-secured loans covered
      by the Home Ownership and Equity Protection Act of 1994, a federal law that
      requires extra disclosures and consumer protections to borrowers. The following
      triggers coverage under the act:





·
            interest
                rates for first lien mortgage loans in excess of 8 percentage points
                above
                the comparable U.S. Treasury securities,


·
            subordinate-lien
                loans of 10 percentage points above U.S. Treasury securities;
                and


·
            fees
                such as optimal insurance and similar debt protection costs paid
                in
                connection with the credit transaction, when combined with points
                and fees
                if deemed excessive.





In
      addition, the regulations bar loan flipping by the same lender or loan servicer
      within a year. Lenders also will be presumed to have violated the law - which
      says the loans shouldn’t be made to people unable to repay them - unless they
      document that the borrower has the ability to repay. Lenders that violate the
      rules face cancellation of loans and penalties equal to the finance charges
      paid.





The
      Bank
      is unable at this time to determine the impact of these rule changes and
      potential state action in this area on its financial condition or results of
      operation.





***Loans-to-One
      Borrower Limitations*** .
      Savings
      associations generally are subject to the lending limits applicable to national
      banks. With certain limited exceptions, the maximum amount that a savings
      association or a national bank may lend to any borrower (including certain
      related entities of the borrower) at one time may not exceed 15% of the
      unimpaired capital and surplus of the institution, plus an additional 10% of
      unimpaired capital and surplus for loans fully secured by readily marketable
      collateral. Savings associations are additionally authorized to make loans
      to
      one borrower, for any purpose, in an amount not to exceed $500,000 or, by order
      of the Director of the OTS, in an amount not to exceed the lesser of $30,000,000
      or 30% of unimpaired capital and surplus to develop residential housing,
      provided:




·
            the
                purchase price of each single-family dwelling in the development
                does not
                exceed $500,000;


·
            the
                savings association is in compliance with its fully phased-in capital
                requirements;


·
            the
                loans comply with applicable loan-to-value requirements; and


·
            the
                aggregate amount of loans made under this authority does not exceed
                150%
                of unimpaired capital and surplus.




At
      December 31, 2006, the Bank’s loans-to-one-borrower limit was $14,917,000 based
      upon the 15% of unimpaired capital and surplus measurement. At December 31,
      2006, the Bank’s largest single lending relationship had an outstanding balance
      of $7,000,000, and consisted of a line of credit secured by assignments of
      notes, Deeds of Trust, pledged stock and certificates of deposit. The loan
      was
      performing in accordance with its terms.





***Qualified
      Thrift Lender Test*** .
      Savings
      associations must meet a QTL test, which test may be met either by maintaining
      a
      specified level of assets in qualified thrift investments as specified in HOLA
      or by meeting the definition of a “domestic building and loan association” as
      defined in the Code. Qualified thrift investments are primarily residential
      mortgages and related investments, including certain mortgage-related
      securities. The required percentage of investments under HOLA is 65% of assets
      while the Code requires investments of 60% of assets. An association must be
      in
      compliance with the QTL test or the definition of domestic building and loan
      association on a monthly basis in nine out of every 12 months. Associations
      that
      fail to meet the QTL test will generally be prohibited from engaging in any
      activity not permitted for both a national bank and a savings association.
      As of
      December 31, 2006, the Bank was in compliance with its QTL requirement and
      met
      the definition of a domestic building and loan association.





26







***Affiliate
      Transactions*** .
      Transactions between a savings association and its "affiliates" are
      quantitatively and qualitatively restricted under the Federal Reserve Act and
      regulations adopted by the Federal Reserve. Affiliates of a savings association
      include, among other entities, the savings association's holding company and
      companies that are under common control with the savings association. In
      general, a savings association or its subsidiaries are limited in their ability
      to engage in "covered transactions" with affiliates:





·
            to
                an amount equal to 10% of the association's capital and surplus,
                in the
                case of covered transactions with any one affiliate; and


·
            to
                an amount equal to 20% of the association's capital and surplus,
                in the
                case of covered transactions with all
                affiliates.




In
      addition, a savings association and its subsidiaries may engage in covered
      transactions and other specified transactions only on terms and under
      circumstances that are substantially the same, or at least as favorable to
      the
      savings association or its subsidiary, as those prevailing at the time for
      comparable transactions with nonaffiliated companies. A "covered transaction"
      includes:





·
            a
                loan or extension of credit to an affiliate;


·
            a
                purchase of investment securities issued by an
                affiliate;


·
            a
                purchase of assets from an affiliate, with some exceptions;


·
            the
                acceptance of securities issued by an affiliate as collateral for
                a loan
                or extension of credit to any party; or


·
            the
                issuance of a guarantee, acceptance or letter of credit on behalf
                of an
                affiliate.





In
      addition, under the OTS regulations:





·
            a
                savings association may not make a loan or extension of credit to
                an
                affiliate unless the affiliate is engaged only in activities permissible
                for bank holding companies;


·
            a
                savings association may not purchase or invest in securities of an
                affiliate other than shares of a subsidiary;


·
            a
                savings association and its subsidiaries may not purchase a low-quality
                asset from an affiliate;


·
            covered
                transactions and other specified transactions between a savings
                association or its subsidiaries and an affiliate must be on terms
                and
                conditions that are consistent with safe and sound banking practices;
                and


·
            with
                some exceptions, each loan or extension of credit by a savings association
                to an affiliate must be secured by collateral with a market value
                ranging
                from 100% to 130%, depending on the type of collateral, the amount
                of the
                loan, or extension of credit.





Regulations
      generally exclude all non-bank and non-savings association subsidiaries of
      savings associations from treatment as affiliates, except for:





·
            a
                financial subsidiary;


·
            a
                subsidiary controlled by one or more
                affiliates;


·
            an
                ESOP; or


·
            a
                subsidiary determined by the OTS or the Federal Reserve to be an
                affiliate.





The
      regulations also require savings associations to make and retain records that
      reflect affiliate transactions in reasonable detail and provide that specified
      classes of savings associations may be required to give the OTS prior notice
      of
      affiliate transactions.





Some
      of
      the entities included in the definition of an affiliate are parent companies,
      sister banks, sponsored and advised companies, investment companies whereby
      the
      bank its affiliate serves as investment advisor, and financial subsidiaries
      of
      the bank. Additional restrictions on transactions with affiliates may be imposed
      on us under the prompt corrective action provisions of federal law. See “Prompt
      Corrective Action.”





27







***Capital
      Distribution Limitations*** .
      OTS
      regulations impose limitations upon all capital distributions by savings
      associations, such as cash dividends, payments to repurchase or otherwise
      acquire its shares, payments to shareholders of another institution in a
      cash-out merger and other distributions charged against capital.





The
      OTS
      regulations require a savings association to file an application
      if:




·
            it
                is not eligible for expedited treatment of its other applications
                under
                OTS regulations;


·
            the
                total amount of all of capital distributions, including the proposed
                capital distribution, for the applicable calendar year exceeds its
                net
                income for that year to date plus retained net income for the preceding
                two years;


·
            it
                would not be at least adequately capitalized, under the prompt corrective
                action regulations of the OTS following the distribution; or


·
            the
                association's proposed capital distribution would violate a prohibition
                contained in any applicable statute, regulation, or agreement between
                the
                savings association and the OTS, or the FDIC, or violate a condition
                imposed on the savings association in an OTS-approved application
                or
                notice.





In
      addition, a savings association must give the OTS notice of a capital
      distribution if the savings association is not required to file an application,
      but:





·
            would
                not be well capitalized under the prompt corrective action regulations
                of
                the OTS following the distribution;


·
            the
                proposed capital distribution would reduce the amount of or retire
                any
                part of the savings association's common or preferred stock or retire
                any
                part of debt instruments like notes or debentures included in capital,
                other than regular payments required under a debt instrument approved
                by
                the OTS; or


·
            the
                savings association is a subsidiary of a savings and loan holding
                company.





If
      neither the savings association nor the proposed capital distribution meets
      any
      of the above listed criteria, the OTS does not require the savings association
      to submit an application or give notice when making the proposed capital
      distribution. The OTS may prohibit a proposed capital distribution that would
      otherwise be permitted if the OTS determines that the distribution would
      constitute an unsafe or unsound practice.





***Branching*** *.* Under
      OTS
      branching regulations, the Bank is generally authorized to open branches within
      or beyond the State of Maryland if the Bank (1) continues to meet the
      requirements of a “highly-rates” federal savings bank. And (2) publishes public
      notice at least 35 days before opening a branch and no one opposes the branch.
      If a comment in opposition to a branch opening is filed and the OTS determines
      the comment to be relevant to the approval process standards, and to require
      action in response, the OTS may, among other things, require a branch
      application or elect to hold a meeting with the Bank and the person who
      submitted the comment. The OTS authority preempts any state law purporting
      to
      regulate branching by federal savings banks. Commercial banks can also branch
      across state lines, subject to any state law limitations or prohibitions.
      Competition may increase further as banks branch across state lines and enter
      new markets.





***Community
      Reinvestment Act and the Fair Lending Laws*** **.** Savings
      associations have a responsibility under the Community Reinvestment Act and
      related regulations of the OTS to help meet the credit needs of their
      communities, including low- and moderate-income neighborhoods. In addition,
      the
      Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from
      discriminating in their lending practices on the basis of characteristics
      specified in those statutes. An institution's failure to comply with the
      provisions of the Community Reinvestment Act could, at a minimum, result in
      regulatory restrictions on its activities and the denial of applications. In
      addition, an institution's failure to comply with the Equal Credit Opportunity
      Act and the Fair Housing Act could result in the OTS, other federal regulatory
      agencies as well as the Department of Justice taking enforcement actions. Based
      on an examination conducted July 7, 2003, the Bank received a satisfactory
      rating.






28


Effective
      January 1, 2002, the OTS raised the dollar amount limit in the definition of
      small business loans from $500,000 to $2.0 million, if used for commercial,
      corporate, business or agricultural purposes. Furthermore, the rule raises
      the
      aggregate level that a thrift can invest directly in community development
      funds, community centers and economic development initiatives in its communities
      from the greater of a quarter of one percent of total capital or $100,000 to
      one
      percent of total capital or $250,000.





***Anti-Money
      Laundering and Customer Identification.*** The
      Bank
      is subject to the OTS Financial Crimes Enforcement Network regulations
      implementing the Bank Secrecy Act, as amended by the USA Patriot Act of 2001.
      The USA Patriot Act gives the federal government powers to address terrorist
      threats through enhanced domestic security measures, expanded surveillance
      powers, increased information sharing, and broadened anti-money laundering
      requirements. By way of amendments to the Bank Secrecy Act, Title III of the
      USA
      Patriot Act takes measures intended to encourage information sharing among
      banks, regulatory agencies and law enforcements bodies. Certain provisions
      of
      the USA Patriot Act impose affirmative obligations on a broad range of financial
      institutions, including savings banks like the Bank.





The
      USA
      Patriot Act and the related OTS regulations impose the following requirements
      with respect to financial institutions:





·
            Establishing
                of anti-money laundering programs, including adoption of written
                procedures, designation of a compliance officer and auditing of the
                program;





·
            Establishment
                of a program specifying procedures for obtaining identifying information
                from customers seeking to open new accounts, including verifying
                the
                identity of customers within a reasonable period of
                time;




·
            Establishment
                of enhanced due diligence policies, procedures and controls designed
                to
                detect and report money laundering;





·
            Prohibition
                on correspondent accounts for foreign shell banks and compliance
                with
                record keeping obligations with respect to correspondent accounts
                of
                foreign banks; and





·
            Requirements
                that bank regulators consider a holding company’s effectiveness in
                combating money laundering when ruling on Federal Reserve Act and
                Bank
                Merger Act applications.





***Federal
      Home Loan Bank System*** .
      The
      Bank is a member of the FHLB-Atlanta. Among other benefits, each FHLB serves
      as
      a reserve or central bank for its members within its assigned region. Each
      FHLB
      is financed primarily from the sale of consolidated obligations of the FHLB
      system. Each FHLB makes available loans or advances to its members in compliance
      with the policies and procedures established by the Board of Directors of the
      individual FHLB. As an FHLB member, the Bank is required to own capital stock
      in
      an FHLB in an amount equal to the greater of:




·
            1%
                of its aggregate outstanding principal amount of its residential
                mortgage
                loans, home purchase contracts and similar obligations at the beginning
                of
                each calendar year; or


·
            5%
                of its FHLB advances or borrowings.





At
      December 31, 2006, the Bank was in compliance with this requirement.





A
      new
      capital plan of the FHLB-Atlanta was implemented on December 17, 2004. It was
      subsequently amended on December 8, 2005, and the amendment was approved by
      the
      regulator of the FHLB-Atlanta, the Federal Housing Finance Board, on January
      25,
      2006. The new capital plan, as amended, authorizes FHLB-Atlanta to issue, redeem
      and repurchase its capital stock at its stated par value of $100 per share.
      Each
      member of FHLB-Atlanta is required to own capital stock in an amount equal
      to
      the sum of:




29





*·*
            the
                membership stock requirement, which is the lesser of:


(i)
      0.20%
      of such member’s total assets as of December 31 of the previous calendar year;
      or


(ii)
      a
      specified dollar cap (initially estimated at $25 million); *plus*





·
            the
                activity-based stock requirement, which is the aggregate of:


(i)
      a
      specified percentage (initially estimated at 4.50%) of the outstanding advances
      from FHLB-Atlanta to each member;


(ii)
      a
      specified percentage (initially estimated at 0.00%) of the “acquired member
      assets” (as defined in FHLB regulations) sold by each member to FHLB-Atlanta;
      and


(iii)
      a
      specified percentage (initially estimated at 8.00%) of any targeted debt/equity
      investment (which satisfies the criteria set forth in the FHLB regulations)
      sold
      by each member to FHLB-Atlanta.





***Nontraditional
      Mortgage Products*** .
      On
      September 29, 2006, the federal banking agencies published final guidance for
      institutions that originate or service nontraditional or alternative mortgage
      products, defined to include all residential mortgage loan products that allow
      borrowers to defer repayment on principal or interest, such as interest-only
      mortgages and payment option adjustable-rate mortgages. A portion of the Bank’s
      adjustable-rate residential mortgage loans are alternative mortgage
      loans.





Recognized
      that alternative mortgage products expose the institutions to increased risks
      as
      compared to traditional loans where payments amortize or reduce the principal
      amount, the guidance required increased scrutiny for alternative mortgage
      products. Institutions that originate or service alternative mortgages should
      have (1) strong risk management practices that include maintenance of capital
      levels and allowance for loan losses commensurate with the risk; (2) prudent
      lending policies and underwriting standards that address the borrower’s
      repayment capacity; and (3) programs and practices designed to ensure that
      consumers receive clear and balanced information to assist in making informed
      decisions about mortgage products. The guidance also recommends heightened
      controls and safeguards when an institution combines an alternative mortgage
      product with features the compound risk, such as a simultaneous second-lien
      or
      the use of reduced documentation to evaluate a loan application.





The
      Bank
      is required to an intends to comply with the guidance as it is interpreted
      and
      applied by the OTS.





***Assessments*** .
      The OTS
      charges assessments to recover the cost of examining federal savings banks
      and
      their affiliates. These assessments are based on three components: (1) the
      size
      of the institution on which the basic assessment is based; (2) the institution’s
      supervisory condition, which results in an additional assessment based on a
      percentage of the basic assessment for any savings institution with a composite
      rating of 3,4 or 5 in its most recent safety and soundness examination; and
      (3)
      the complexity of the institution’s operations, which results in an additional
      assessment based on a percentage of the basic assessment for any savings
      institution that managed over $1 billion in trust assets, serviced for others
      loans aggregating more than $1 billion, or had certain off-balance sheet assets
      aggregating more than $1 billion.





The
      OTS
      also assesses fees against savings and loan holding companies such as the
      Bancorp. The OTS semi-annual assessment for savings and loan holding companies
      includes a $3,000 base assessment with an additional assessment based on the
      holding company’s risk or complexity, organizational form and
      condition.





***Federal
      Reserve System*** .
      The FRB
      requires all depository institutions to maintain non-interest bearing reserves
      at specified levels against their transaction accounts (primarily checking,
      NOW,
      and Super NOW checking accounts) and non-personal time deposits. At December
      31,
      2006, the Bank was in compliance with these requirements.





***Activities
      of Subsidiaries*** .
      A
      savings association seeking to establish a new subsidiary, acquire control
      of an
      existing company or conduct a new activity through a subsidiary must provide
      30
      days prior notice to the FDIC and the OTS and conduct any activities of the
      subsidiary in compliance with regulations and orders of the OTS. The OTS has
      the
      power to require a savings association to divest any subsidiary or terminate
      any
      activity conducted by a subsidiary that the OTS determines to pose a serious
      threat to the financial safety, soundness or stability of the savings
      association or to be otherwise inconsistent with sound banking
      practices.






30






**Item
      1A. Risk Factors**





Unless
      the context indicates otherwise, all references to “we,” “us,” “our” in this
      subsection “Risk Factors” refer to the Bancorp and its subsidiaries. You should
      carefully consider the risks described below as well as elsewhere in this Annual
      Report on Form 10-K. If any of the risks actually occur, our business, financial
      condition or results of future operations could be materially adversely
      affected. This Annual Report on Form 10-K contains forward-looking statements
      that involve risk and uncertainties. Our actual results could differ materially
      from those anticipated in the forward-looking statements as a result of many
      factors, including the risks faced by us described below and elsewhere in this
      Annual Report on Form 10-K.





**We
      may be adversely affected by changes in economic and political conditions and
      by
      governmental monetary and fiscal policies.**





The
      thrift industry is affected, directly and indirectly, by local, domestic, and
      international economic and political conditions, and by governmental monetary
      and fiscal policies. Conditions such as inflation, recession, unemployment,
      volatile interest rates, tight money supply, real estate values, international
      conflicts and other factors beyond our control may adversely affect our
      potential profitability. Any future rises in interest rates, while increasing
      the income yield on our earning assets, may adversely affect loan demand and
      the
      cost of funds and, consequently, our profitability. Any future decreases in
      interest rates may adversely affect our profitability because such decreases
      may
      reduce the amounts that we may earn on our assets. Economic downturns could
      result in the delinquency of outstanding loans. We do not expect any one
      particular factor to materially affect our results of operations. However,
      downtrends in several areas, including real estate, construction and consumer
      spending, could have a material adverse impact on our ability to remain
      profitable.





**Changes
      in interest rates could adversely affect our financial condition and results
      of
      operations.**





The
      operations of financial institutions, such as us, are dependent to a large
      degree on net interest income, which is the difference between interest income
      from loans and investments and interest expense on deposits and borrowings.
      Our
      net interest income is significantly affected by market rates of interest that
      in turn are affected by prevailing economic conditions, by the fiscal and
      monetary policies of the federal government and by the policies of various
      regulatory agencies. Like all financial institutions, our balance sheet is
      affected by fluctuations in interest rates. Volatility in interest rates can
      also result in disintermediation, which is the flow of funds away from financial
      institutions into direct investments, such as US Government and corporate
      securities and other investment vehicles, including mutual funds, which, because
      of the absence of federal insurance premiums and reserve requirements, generally
      pay higher rates of return than financial institutions.





**Most
      of our loans are secured by real estate located in our market area. If there
      is
      a downturn in our real estate market, these borrowers may default on their
      loans
      and we may not be able to fully recover our loans.**





A
      downturn in the real estate market could hurt our business because most of
      our
      loans are secured by real estate. Substantially all of our real property
      collateral is located in the states of Maryland, Virginia and Delaware. As
      of
      December 31, 2006, approximately 95% of the book value of our loan portfolio
      consisted of loans collateralized by various types of real estate. Real estate
      values and real estate markets are generally affected by changes in national,
      regional or local economic conditions, fluctuations in interest rates and the
      availability of loans to potential purchasers, changes in tax laws and other
      governmental statutes, regulations and policies and acts of nature. If real
      estate prices decline, the value of real estate collateral securing our loans
      could be reduced. Our ability to recover on defaulted loans by foreclosing
      and
      selling the real estate collateral would then be diminished and we would be
      more
      likely to suffer losses on defaulted loans. Any such downturn could have a
      material adverse effect on our business, financial condition and results of
      operations.





In
      addition, approximately 65% of the book value of our loans consisted of
      construction, land acquisition and development loans, commercial real estate
      loans and land loans, which present additional risks described in “Item 1.
      Business”.






31





**We
      are exposed to risk of environmental liabilities with respect to properties
      to
      which we take title.**





In
      the
      course of our business, we may foreclose and take title to real estate, and
      could be subject to environmental liabilities with respect to these properties.
      We may be held liable to a governmental entity or to third parties for property
      damage, personal injury, investigation and clean-up costs incurred by these
      parties in connection with environmental contamination, or may be required
      to
      investigate or clean up hazardous or toxic substances, or chemical releases
      at a
      property. The costs associated with investigation or remediation activities
      could be substantial. In addition, if we are the owner or former owner of a
      contaminated site, we may be subject to common law claims by third parties
      based
      on damages and costs resulting from environmental contamination emanating from
      the property. If we become subject to significant environmental liabilities,
      our
      business, financial condition, results of operations and cash flows could be
      materially adversely affected.





**Our
      operations are located in Anne Arundel County, Maryland, which makes our
      business highly susceptible to local economic conditions, and an economic
      downturn or recession in that area may adversely affect our ability to operate
      profitably.**





Unlike
      larger banking organizations that are more geographically diversified, our
      operations are currently concentrated in Anne Arundel County, Maryland. In
      addition, almost all of our loans have been made to borrowers in the states
      of
      Maryland, Virginia and Delaware. As a result of this geographic concentration,
      our financial results depend largely upon economic conditions in this market
      area. A deterioration or recession in economic conditions in this market could
      result in one or more of the following:





·
            a
                decrease in deposits;


·
            an
                increase in loan delinquencies;


·
            an
                increase in problem assets and
                foreclosures;


·
            a
                decrease in the demand for our products and services;
                and


·
            a
                decrease in the value of collateral for loans, especially real estate,
                and
                reduction in the customers’ borrowing
                power.





Any
      of
      the foregoing factors may adversely affect our ability to operate
      profitably.





**We
      are subject to federal and state regulation**  **and
      the monetary policies of the Federal Reserve Board. Such regulation and policies
      can have a material adverse effect on our earnings and
      prospects.**





Our
      operations are heavily regulated and will be affected by present and future
      legislation and by the policies established from time to time by various federal
      and state regulatory authorities. In particular, the monetary policies of the
      Federal Reserve Board have had a significant effect on the operating results
      of
      banks in the past, and are expected to continue to do so in the future. Among
      the instruments of monetary policy used by the Federal Reserve Board to
      implement its objectives are changes in the discount rate charged on bank
      borrowings and changes in the reserve requirements on bank deposits. It is
      not
      possible to predict what changes, if any, will be made to the monetary polices
      of the Federal Reserve Board or to existing federal and state legislation or
      the
      effect that such changes may have on our future business and earnings prospects





**We
      have established an allowance for loan losses based on our management's
      estimate. Actual losses could differ significantly from those
      estimates.**  **If
      the allowance is not adequate, it could have a material adverse effect on our
      earnings and the price of our stock.**





We
      have
      established an allowance for loan losses which management believes to be
      adequate to offset probable losses on our existing loans. However, there is
      no
      precise method of estimating loan losses and our ongoing analysis may cause
      this
      estimate to change in the future and actual losses may differ materially from
      this estimate. In addition, there can be no assurance that any future declines
      in real estate market conditions, general economic conditions or changes in
      regulatory policies will not require us to increase our allowance for loan
      losses. Any increase in the allowance for loan losses will reduce our earnings
      and may adversely affect the price of our common stock.






32






**We
      compete with a number of local, regional and national financial institutions
      for
      customers** .





We
      face
      strong competition from other thrifts, banks, savings institutions and other
      financial institutions that have branch offices or otherwise operate in our
      market area, as well as many other companies now offering a range of financial
      services. Many of these competitors have substantially greater financial
      resources and larger branch systems than we do. In addition, many of our
      competitors have higher legal lending limits than we do. Particularly intense
      competition exists for sources of funds including savings and retail time
      deposits and for loans, deposits and other services that we offer.





During
      the past several years, significant legislative attention has been focused
      on
      the regulation and deregulation of the financial services industry. Non-bank
      financial institutions, such as securities brokerage firms, insurance companies
      and money market funds, have been permitted to engage in activities that compete
      directly with traditional bank business. Competition with various financial
      institutions could hinder our ability to maintain profitable operations and
      grow
      our business.




**Our
      information systems may experience an interruption or breach in security, which
      could result in a loss of business.**





We
      rely
      heavily on communications and information systems to conduct our business.
      Any
      failure, interruption or breach in security of these systems could result in
      failures or disruptions in our customer relationship management, general ledger,
      deposit, loan and other systems. While we have policies and procedures designed
      to prevent or limit the effect of the failure, interruption or security breach
      of our information systems, there can be no assurance that failures,
      interruptions or security breaches will not occur or, if they do occur, that
      they will be adequately addressed. The occurrence of any failures, interruptions
      or security breaches of our information systems could damage our reputation,
      result in a loss of customer business, subject us to additional regulatory
      scrutiny, or expose us to civil litigation and possible financial liability,
      any
      of which could have a material adverse effect on our financial condition and
      results of operations. We depend on third-party providers for many of our
      systems and if these providers experience financial, operational or
      technological difficulties, or if there is any other disruption in our
      relationships with them, we may be required to locate alternative sources of
      such services, and we cannot assure you that we would be able to negotiate
      terms
      that are as favorable to us, or could obtain services with similar functionality
      as found in our existing systems without the need to expend substantial
      resources, if at all.





**We
      continually encounter technological change, and, if we are unable to develop
      and
      implement efficient and customer friendly technology, we could lose
      business.**





The
      financial services industry is continually undergoing rapid technological change
      with frequent introductions of new technology-driven products and services.
      The
      effective use of technology increases efficiency and enables financial
      institutions to better serve customers and to reduce costs. Our future success
      depends, in part, upon our ability to address the needs of our customers by
      using technology to provide products and services that will satisfy customer
      demands, as well as to create additional efficiencies in our operations. Many
      of
      our competitors have substantially greater resources to invest in technological
      improvements. We may not be able to effectively implement new technology-driven
      products and services or be successful in marketing these products and services
      to our customers. Failure to successfully keep pace with technological change
      affecting the financial services industry could have a material adverse impact
      on our business and, in turn, our financial condition and results of
      operations.


**There
      can be no assurance that we will continue to pay dividends in the
      future** .





Although
      we expect to continue our policy of regular quarterly dividend payments, this
      dividend policy will be reviewed periodically in light of future earnings,
      regulatory restrictions and other considerations. No assurance can be given,
      therefore, that cash dividends on common stock will be paid in the future at
      the
      same rate or at all.






33






**An
      investment in our common stock is not insured against loss.**





Investments
      in the shares of our common stock are not deposits insured against loss by
      the
      FDIC or any other entity. As a result, you may lose some or all of your
      investment.





**Our
      success depends on our senior management team and if we are not able to retain
      them, it could have a materially adverse effect on us.**





We
      are
      highly dependent upon the continued services and experience of our senior
      management team, including Alan J. Hyatt, our President and Chief Executive
      Officer. We depend on the services of Mr. Hyatt and the other members of our
      senior management team to, among other things, continue the development and
      implementation of our strategies, and maintain and develop our client
      relationships. We do not have an employment agreement with members of our senior
      management nor do we maintain “key-man” life insurance on our senior management.





“ **Anti-takeover”
      provisions may make it more difficult for a third party to acquire control
      of
      us, even if the change in control would be beneficial to
      shareholders.**





Our
      charter presently contains certain provisions which may be deemed to be
      "anti-takeover" and "anti-greenmail" in nature in that such provisions may
      deter, discourage or make more difficult the assumption of control of us by
      another corporation or person through a tender offer, merger, proxy contest
      or
      similar transaction or series of transactions. For example, our charter provides
      that our board of directors may issue up to 1,000,000 shares of preferred stock
      without shareholder approval. In addition, our charter provides for a classified
      board, with each board member serving a staggered three-year term. Directors
      may
      be removed only for cause and only with the approval of the holders of at least
      75 percent of our common stock. The overall effects of the "anti-takeover"
      and
      "anti-greenmail" provisions may be to discourage, make more costly or more
      difficult, or prevent a future takeover offer, prevent shareholders from
      receiving a premium for their securities in a takeover offer, and enhance the
      possibility that a future bidder for control of us will be required to act
      through arms-length negotiation with the our board of directors.





**If
      we fail to maintain an effective system of internal control over financial
      reporting and disclosure controls and procedures, we may be unable to accurately
      report our financial results and comply with the reporting requirements under
      the Securities Exchange Act of 1934. As a result, current and potential
      shareholders may lose confidence in our financial reporting and disclosure
      required under the Securities Exchange Act of 1934, which could adversely affect
      our business and we could be subject to regulatory
      scrutiny.**





Pursuant
      to Section 404 of the Sarbanes-Oxley Act of 2002, referred to as Section 404,
      we
      are required to include in our Annual Reports on Form 10-K, our management’s
      report on internal control over financial reporting and our registered public
      accounting firm’s attestation report on our management’s assessment of our
      internal control over financial reporting. While we have reported no or
“material weaknesses in this Form 10-K, we cannot guarantee that we will not
      have any “significant deficiencies” or “material weaknesses” reported by our
      independent registered public accounting firm in the future. Compliance with
      the
      requirements of Section 404 is expensive and time-consuming. If in the future
      we
      fail to complete this evaluation in a timely manner, or if our independent
      registered public accounting firm cannot timely attest to our evaluation, we
      could be subject to regulatory scrutiny and a loss of public confidence in
      our
      internal control over financial reporting. In addition, any failure to establish
      an effective system of disclosure controls and procedures could cause our
      current and potential shareholders and customers to lose confidence in our
      financial reporting and disclosure required under the Securities Exchange Act
      of
      1934, which could adversely affect our business.






34






**Terrorist
      attacks and threats or actual war may impact all aspects of our operations,
      revenues, costs and stock price in unpredictable ways.**





Recent
      terrorist attacks in the United States and abroad, as well as future events
      occurring in response to or in connection with them, including, without
      limitation, future terrorist attacks against United States targets, rumors
      or
      threats of war, actual conflicts involving the United States or its allies
      or
      military or trade disruptions, may impact our operations. Any of these events
      could cause consumer confidence and savings to decrease or result in increased
      volatility in the United States and worldwide financial markets and economy. Any
      of these occurrences could have an adverse impact on our operating results,
      revenues and costs and may result in the volatility of the market price for
      our
      common stock and on the future price of our common stock.





**Item
      1B. Unresolved Staff Comments**





None





**Item
      2. Properties**





Bancorp
      has four retail branch locations in Anne Arundel County, Maryland, of which
      it
      owns three and leases the fourth. The Bank, Homeowner’s Title, and HC all lease
      their executive and administrative offices located in Annapolis, Maryland from
      HS West LLC, a wholly owned subsidiary of the Bank. HS West LLC owns its office
      building in Annapolis, Maryland. In addition, the Bank leases office space
      in
      Annapolis Maryland from a third party.





HS
      West
      LLC is a subsidiary of the Bank, and is constructing a building in Annapolis,
      Maryland that effective January 2007 will serve as Bancorp’s and the Bank’s
      administrative headquarters. A branch office of the Bank is included. As of
      December 31, 2006, HS West LLC has incurred approximately  $26,312,000
      of costs, which are included in land and construction in progress. The total
      cost, which includes build-outs on leased space, is expected to be
      approximately  $28,000,000
      with completion mid 2007. HS West LLC has entered into agreements to lease
      all
      the remaining space in the building not occupied by the Bank and
      Bancorp.




**Item
      3. Legal Proceedings**





There
      are
      no material pending legal proceedings to which Bancorp, the Bank or any
      subsidiary is a party or to which any of their property is subject.





**Item
      4. Submission of Matters to a Vote of Security Holders**





None.





**Executive
      Officers of the Registrant that are not Directors.**





Thomas
      G.
      Bevivino, age 51, has served as the Chief Financial Officer of Bancorp since
      July 1, 2005. He serves in the same capacity for the Bank. Mr. Bevivino was
      a
      financial consultant from 2002 until 2004, and served as Chief Financial Officer
      of Luminant Worldwide Corporation from 1999 until 2002.






35


**PART
      II**





**Item
      5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities**





The
      graph
      below sets forth comparative information regarding the Company’s cumulative
      shareholder return on its Common Stock over the last five years. Total
      shareholder return is measured by dividing total dividends (assuming dividend
      reinvestment) for the measurement period plus share price change for a period
      by
      the share price at the beginning of the measurement period. *Severn
      Bancorp, Inc.'s cumulative shareholder return is based on an investment of
      $100
      on December 31, 2001, and is compared to the cumulative total return of the
      NASDAQ Composite Index and the SNL Securities LC Thrift Index for thrifts with
      total assets between $500 million and $1.0 billion (the "SNL Thrift ($500M
      to
      $1.0B) Index")*





**Comparison
      of Cumulative Total Return Among Severn, NASDAQ Composite
      Index**


**and
      SNL Thrift ($500M to $1.0B) Index from December 31, 2001 to December 31,
      2006**










***Period
                  Ending******Index***
              **12/31/01**
              **12/31/02**
              **12/31/03**
              **12/31/04**
              **12/31/05**
              **12/31/06**Severn
                  Bancorp, Inc.
              100.00
              180.88
              364.92
              559.00
              456.67
              502.73NASDAQ
                  Composite Index
              100.00
              68.76
              103.67
              113.16
              115.57
              127.58SNL
                  $500M-$1B Thrift Index
              100.00
              140.09
              199.47
              220.65
              209.70
              256.94











36





Quarterly
      Stock Information*





**2006**Closing
            
            **2005**ClosingStock
                Price Range
            Per
                Share
            
            
            Stock
                Price Range
            Per
                ShareQuarter
            Low
            High
            Dividend
            
            Quarter
            Low
            High
            Dividend1st
            $16.72
            $19.97
            $.060
            
            1st
            $17.28
            $21.02
            $.0552nd
            17.86
            20.13
            .060
            
            2nd
            15.79
            17.87
            .0553rd
            18.48
            19.97
            .060
            
            3rd
            15.83
            17.87
            .0554th
            18.55
            19.80
            .060
            
            4th
            16.20
            17.56
            .055





*Retroactively
      adjusted to reflect 10% stock dividend declared February 21, 2006 effective
      for
      shares outstanding on March 28, 2006.





The
      common stock of Bancorp is traded on the Nasdaq Capital Market under the symbol
      “SVBI”. As of February 22, 2007, there were 214 stockholders of Bancorp’s common
      stock.





Registrar
      and Transfer Company, 10 Commerce Drive, Cranford, New Jersey 07016-3572, serves
      as the Transfer Agent and Registrar for Bancorp.





Bancorp’s
      main source of income is dividends from the Bank. As a result, Bancorp’s
      quarterly dividends to its shareholders will depend primarily upon receipt
      of
      dividends from the Bank. For regulatory restrictions on the Bank’s ability to
      pay dividends, see note 12 to the consolidated financial
      statements.





See
      Item
      12 of this Annual Report on Form 10-K and Notes 9 and 11 to the consolidated
      financial statements for information regarding equity compensation
      plans.













37





**Item
      6. Selected Financial Data**








For
      information concerning quarterly financial data for Bancorp, see note 17 to
      the
      consolidated financial statements.





The
      following financial information is derived from the audited financial statements
      of Bancorp. The information is a summary and should be read in conjunction
      with
      Bancorp’s audited financial statements and Management’s Discussion and Analysis
      of Financial Condition and Results of Operations.





**Summary
      Financial and Other Data**





At
                December 31,2006
            
            2005
            
            2004
            
            2003
            
            2002(dollars
                in thousands, except per share information)Balance
                Sheet DataTotal
                assets
            
            $
            911,916
            
            $
            849,774
            
            $
            703,616
            
            $
            540,471
            
            $
            458,415Total
                loans, net
            
            
            835,477
            
            
            779,333
            
            
            656,967
            
            
            506,026
            
            
            418,825Investment
                securities held to maturity
            
            
            7,271
            
            
            8,290
            
            
            9,955
            
            
            12,721
            
            
            9,661Non-performing
                loans
            
            
            5,927
            
            
            1,693
            
            
            939
            
            
            469
            
            
            1,758Total
                non-performing assets
            
            
            6,897
            
            
            1,693
            
            
            939
            
            
            469
            
            
            1,982Deposits
            
            
            626,524
            
            
            594,893
            
            
            527,413
            
            
            419,726
            
            
            377,925Short-term
                borrowings
            
            
            18,000
            
            
            26,000
            
            
            -
            
            
            6,000
            
            
            -Long-term
                debt
            
            
            155,000
            
            
            132,000
            
            
            89,000
            
            
            59,000
            
            
            34,000Total
                liabilities
            
            
            825,474
            
            
            777,062
            
            
            639,462
            
            
            487,501
            
            
            415,233Stockholders’
                equity
            
            
            86,442
            
            
            72,712
            
            
            60,154
            
            
            48,970
            
            
            39,181Book
                value per common share *
            
            $
            9.45
            
            $
            7.95
            
            $
            6.57
            
            $
            5.35
            
            $
            4.30Common
                shares outstanding *
            
            
            9,150,850
            
            
            9,150,002
            
            
            9,150,002
            
            
            9,150,002
            
            
            9,113,702Other
                Data:Number
                of:Full
                service retail banking facilities
            
            
            3
            
            
            3
            
            
            3
            
            
            2
            
            
            2Full-time
                equivalent employees
            
            
            121
            
            
            111
            
            
            105
            
            
            81
            
            
            69*
                Retroactively adjusted to reflect 10% stock dividend declared February
                21,
                2006 effective for shares outstanding on March 28, 2006 and a two-for-one
                stock split declared November 17, 2004 effective for shares outstanding
                December 15, 2004.





38





**Summary
      of Operations**


For
                the Year Ended December 31,2006
            
            2005
            
            2004
            
            2003
            
            2002(dollars
                in thousands, except per share information)Interest
                and dividend income
            
            $
            70,175
            
            $
            57,135
            
            $
            44,829
            
            $
            37,087
            
            $
            33,402Interest
                expense
            
            
            32,060
            
            
            21,955
            
            
            14,631
            
            
            12,341
            
            
            13,799Net
                interest income
            
            
            38,115
            
            
            35,180
            
            
            30,198
            
            
            24,746
            
            
            19,603Provision
                for loan losses
            
            
            1,561
            
            
            1,570
            
            
            1,200
            
            
            900
            
            
            670Net
                interest income after provision for loan losses
            
            
            36,554
            
            
            33,610
            
            
            28,998
            
            
            23,846
            
            
            18,933Non-interest
                income
            
            
            3,867
            
            
            2,748
            
            
            3,402
            
            
            4,674
            
            
            4,133Non-interest
                expense
            
            
            14,065
            
            
            12,878
            
            
            11,211
            
            
            9,616
            
            
            8,447Income
                before income tax provision
            
            
            26,356
            
            
            23,480
            
            
            21,189
            
            
            18,904
            
            
            14,619Provision
                for income taxes
            
            
            10,608
            
            
            8,926
            
            
            8,258
            
            
            7,575
            
            
            5,671Net
                income
            
            $
            15,748
            
            $
            14,554
            
            $
            12,931
            
            $
            11,329
            
            $
            8,948Per
                Share Data:Basic
                earnings per share *
            
            $
            1.72
            
            $
            1.59
            
            $
            1.42
            
            $
            1.22
            
            $
            0.96Diluted
                earnings per share *
            
            $
            1.72
            
            $
            1.59
            
            $
            1.42
            
            $
            1.22
            
            $
            0.96Weighted
                number of shares outstanding basic *
            
            
            9,150,263
            
            
            9,150,002
            
            
            9,150,002
            
            
            9,122,445
            
            
            9,002,814Weighted
                number of shares outstanding diluted *
            
            
            9,153,687
            
            
            9,150,002
            
            
            9,150,002
            
            
            9,146,064
            
            
            9,027,091*
                Retroactively adjusted to reflect 10% stock dividend declared February
                21,
                2006 effective for shares outstanding on March 28, 2006 and a two-for-one
                stock split declared November 17, 2004 effective for shares outstanding
                December 15, 2004.














39





**Key
      Operating Ratios**





For
                the Year Ended December 31,2006
            
            2005
            
            2004
            
            2003
            
            2002**Performance
                Ratios:**Return
                on average assets
            
            
            1.77
            %
            
            1.84
            %
            
            2.02
            %
            
            2.23
            %
            
            2.14
            %Return
                on average equity
            
            
            19.59
            %
            
            21.85
            %
            
            23.56
            %
            
            25.22
            %
            
            25.58
            %Dividend
                payout ratio
            
            
            13.95
            %
            
            13.84
            %
            
            13.38
            %
            
            12.30
            %
            
            11.46
            %Net
                interest margin
            
            
            4.50
            %
            
            4.58
            %
            
            4.81
            %
            
            4.99
            %
            
            4.86
            %Interest
                rate spread
            
            
            4.20
            %
            
            4.32
            %
            
            4.60
            %
            
            4.77
            %
            
            4.59
            %Non-interest
                expense to average assets
            
            
            1.58
            %
            
            1.63
            %
            
            1.75
            %
            
            1.89
            %
            
            2.02
            %Efficiency
                ratio
            
            
            33.50
            %
            
            33.95
            %
            
            33.37
            %
            
            32.69
            %
            
            35.59
            %**Asset
                Quality Ratios:**Average
                equity to average assets
            
            
            9.02
            %
            
            8.42
            %
            
            8.57
            %
            
            8.84
            %
            
            8.38
            %Nonperforming
                assets to total assetsat
                end of period
            
            
            0.76
            %
            
            0.20
            %
            
            0.13
            %
            
            0.09
            %
            
            0.43
            %Nonperforming
                loans to total grossloans
                at end of period
            
            
            0.62
            %
            
            0.18
            %
            
            0.12
            %
            
            0.08
            %
            
            0.36
            %Allowance
                for loan losses tonet
                loans at end of period
            
            
            1.08
            %
            
            0.96
            %
            
            0.90
            %
            
            0.95
            %
            
            0.95
            %Allowance
                for loan losses tononperforming
                loans at end of period
            
            
            152.29
            %
            
            443.30
            %
            
            632.10
            %
            
            1030.49
            %
            
            227.02
            %








40


**Average
      Balance Sheet**


Average
      Balance Sheet. The following table contains for the periods indicated
      information regarding the total dollar amounts of interest income from
      interest-earning assets and the resulting average yields, the total dollar
      amount of interest expense on interest-bearing liabilities and the resulting
      average costs, net interest income, and the net yield on interest-earning
      assets.




Years
                Ended December 31,2006
            
            2005
            
            2004Average
            
            
            
            Average
            
            
            
            AverageVolume
            Interest
            Yield/Cost
            
            Volume
            Interest
            Yield/Cost
            
            Volume
            Interest
            Yield/Cost(dollars
                in thousands)ASSETSLoans
                (1)
            
            $819,038
            $68,610
            8.38%
            
            $738,028
            $56,120
            7.60%
            
            $600,030
            $44,091
            7.35%Investments
                (2)
            
            5,000
            154
            3.08%
            
            5,000
            154
            3.08%
            
            5,250
            165
            3.15%Mortgage-backed
                securities
            
            2,823
            112
            3.97%
            
            4,065
            173
            4.26%
            
            5,686
            254
            4.46%Other
                interest-earning assets (3)
            
            19,886
            1,299
            6.53%
            
            15,923
            688
            4.32%
            
            12,656
            319
            2.52%Total
                interest-earning assets
            
            846,747
            70,175
            8.29%
            
            763,016
            57,135
            7.49%
            
            623,622
            44,829
            7.19%Non-interest
                earning assets
            
            44,385
            
            
            
            28,027
            
            
            
            16,552Total
                Assets
            
            $891,132
            
            
            
            $791,043
            
            
            
            $640,174LIABILITIES
                AND STOCKHOLDERS' EQUITYSavings
                and checking deposits
            
            $138,242
            $2,728
            1.97%
            
            $155,513
            $2,455
            1.58%
            
            $192,946
            $2,670
            1.38%Certificates
                of deposits
            
            483,524
            20,977
            4.34%
            
            408,026
            13,819
            3.39%
            
            284,636
            8,622
            3.03%Borrowings
            
            162,417
            8,355
            5.14%
            
            134,833
            5,681
            4.21%
            
            96,250
            3,339
            3.47%Total
                interest-bearing liabilities
            
            784,183
            32,060
            4.09%
            
            698,372
            21,955
            3.14%
            
            573,832
            14,631
            2.55%Non-interest
                bearing liabilities
            
            26,556
            
            
            
            26,059
            
            
            
            11,451Stockholders'
                equity
            
            80,393
            
            
            
            66,612
            
            
            
            54,891Total
                liabilities and stockholders' equity
            
            $891,132
            
            
            
            $791,043
            
            
            
            $640,174Net
                interest income and Interest rate spread
            
            
            $38,115
            4.20%
            
            
            $35,180
            4.35%
            
            
            $30,198
            4.64%Net
                interest margin
            
            
            
            4.50%
            
            
            
            4.61%
            
            
            
            4.84%Average
                interest-earning assets toaverage
                interest-bearing liabilities
            
            
            
            107.98%
            
            
            
            109.26%
            
            
            
            108.68%(1)
                Non-accrual loans are included in the average balances and in the
                computation of yields.(2)
                Bancorp does not have any tax-exempt securities.(3)
                Other interest earning assets includes interest bearing deposits
                in other
                banks, federal funds, and FHLB stock investments.








41


**Rate
      Volume Table**





Year
                ended December 31, 2006
            
            Year
                ended December 31, 2005vs.
            
            vs.Year
                ended December 31, 2005
            
            Year
                ended December 31, 2004Total
            
            Changes
                Due to
            
            Total
            
            Changes
                Due toChange
            
            Volume
                (1)
            
            Rate
                (1)
            
            Change
            
            Volume
                (1)
            
            Rate
                (1)(dollars
                in thousands)Interest-earning
                assetsLoans
            
            $
            12,490
            
            $
            6,160
            
            $
            6,330
            
            $
            12,029
            
            $
            10,140
            
            $
            1,889Investments
            
            
            -
            
            
            -
            
            
            -
            
            
            (11
            )
            
            (8
            )
            
            (3
            )Mortgage-backed
                securities
            
            
            (61
            )
            
            (53
            )
            
            (8
            )
            
            (81
            )
            
            (72
            )
            
            (9
            )Other
                interest-earning assets
            
            
            611
            
            
            171
            
            
            440
            
            
            369
            
            
            82
            
            
            287Total
                interest income
            
            $
            13,040
            
            $
            6,278
            
            $
            6,762
            
            $
            12,306
            
            $
            10,142
            
            $
            2,164Interest-bearing
                liabilitiesSavings
                and checking deposits
            
            $
            273
            
            $
            (272
            )
            $
            545
            
            $
            (215
            )
            $
            (518
            )
            $
            303Certificates
                of deposits
            
            
            7,158
            
            
            2,557
            
            
            4,601
            
            
            5,197
            
            
            3,738
            
            
            1,459Borrowings
            
            
            2,674
            
            
            1,162
            
            
            1,512
            
            
            2,342
            
            
            1,338
            
            
            1,004Total
                interest expense
            
            $
            10,105
            
            $
            3,447
            
            $
            6,658
            
            $
            7,324
            
            $
            4,558
            
            $
            2,766Net
                change in interest income
            
            $
            2,935
            
            $
            2,831
            
            $
            104
            
            $
            4,982
            
            $
            5,584
            
            $
            (602
            )(1)
                Changes in interest income/expense not arising from volume or rate
                variances are allocated proportionately to rate and
                volume.





**Item
      7. Management's Discussion and Analysis of Financial Condition and Results
      of
      Operation**





**Critical
      Accounting Policies**





Bancorp’s
      significant accounting policies are set forth in note 1 of the consolidated
      financial statements for the year ended December 31, 2006 which are set forth
      on
      pages F-1 through F-35. Of these significant accounting policies, Bancorp
      considers the policy regarding the allowance for loan losses to be its most
      critical accounting policy, given the uncertainty in evaluating the level of
      the
      allowance required to cover credit losses inherent in the loan portfolio and
      the
      material effect that such judgments can have on the results of operations.
      In
      addition, changes in economic conditions can have a significant impact on the
      allowance for loan losses and therefore the provision for loan losses and
      results of operations. Bancorp has developed policies and procedures for
      assessing the adequacy of the allowance for loan losses, recognizing that this
      process requires a number of assumptions and estimates with respect to its
      loan
      portfolio. Bancorp’s assessments may be impacted in future periods by changes in
      economic conditions, the impact of regulatory examinations, and the discovery
      of
      information with respect to borrowers that is not known to management at the
      time of the issuance of the consolidated financial statements.


42





**Overview**





The
      primary business of Bancorp is consumer deposit products and residential and
      commercial mortgages. Bancorp operates primarily in Anne Arundel County,
      Maryland, as well as surrounding areas in Maryland, northern Virginia and
      Delaware. The demand for construction lending and residential mortgages has
      slowed during 2006 compared to activity in 2005. In addition, the interest
      rate
      spread between Bancorp’s cost of funds and what it earns on loans has decreased
      from 2005, as increases in interest rates paid on deposits and borrowings has
      outpaced interest earned on loans.





Even
      though the interest rate spread has decreased throughout 2006, Bancorp’s
      revenues have increased as its loan portfolio has increased from 2005. In
      addition, while variable expenses, such as compensation, have increased,
      Bancorp’s overall expenses have remained modest, which has resulted in increased
      profitability.





Bancorp’s
      asset quality has remained good, as there have been minimal losses due to
      defaulting loans.





Going
      forward, Bancorp’s challenge will be to continue to grow assets in the form of
      mortgage loans, while earning a profitable spread, and continuing to maintain
      good asset quality. In addition, Bancorp will be challenged to keep overhead
      low
      as costs of its new headquarters are realized starting in 2007.





Interest
      rates are outside the control of Bancorp, so it must attempt to balance its
      pricing and duration of its loan portfolio against the risks of rising costs
      of
      its deposits and borrowings.





The
      continued success and attraction of Anne Arundel County, Maryland, and vicinity,
      will also be important to Bancorp’s ability to originate and grow its mortgage
      loans, as will Bancorp’s continued focus on maintaining a low overhead.





**Financial
      Condition**





Total
      assets increased by $62,142,000, or 7.3%, at December 31, 2006 to $911,916,000,
      compared to $849,774,000 at December 31, 2005. The following discusses the
      material changes between the December 31, 2006 and 2005 balance
      sheets.





**Loans**





**Loans
      Held For Sale.** Loans
      held for sale decreased by $246,000, or 7.6% at December 31, 2006 to $2,970,000,
      compared to $3,216,000 at December 31, 2005. This decrease was primarily due
      to
      a slowdown in loans sold on the secondary market, and the timing of loans
      pending sale at year-end.





**Loans
      Receivable.** Total
      net
      portfolio loans receivable increased by $56,390,000, or 7.3% at December 31,
      2006, to $832,507,000, compared to $776,117,000 at December 31, 2005. The
      increase in the loan portfolio resulted from the strong loan demand during
      the
      first half of 2006; however, Bancorp experienced a general slowdown in loan
      demand during the second half of 2006. The increase in the loan portfolio
      included increases in residential loans, commercial real estate loans and land
      loans.





**Premises
      and Equipment**





Premises
      and equipment increased by $10,448,000, or 52.3% at December 31, 2006 to
      $30,411,000, compared to $19,963,000 at December 31, 2005. The increase was
      primarily due to construction costs incurred during 2006 for Bancorp’s new
      administrative headquarters that opened January 2007.










43


**Liabilities**





**Deposits.** Total
      deposits increased by $31,631,000, or 5.3% at December 31, 2006 to $626,524,000,
      compared to $594,893,000 at December 31, 2005. This increase was primarily
      attributable to growth in certificates of deposit partially offset by a decrease
      in money market accounts. The net increase in deposits was primarily used to
      fund loan growth.





**FHLB
      Advances.** FHLB
      advances increased $15,000,000, or 9.5% at December 31, 2006 to $173,000,000,
      compared to $158,000,000 at December 31, 2005. This increase was the result
      of
      management’s decision to borrow funds from FHLB at more favorable rates than
      would have been necessary to attract the needed funds through customer
      deposits.





**Subordinated
      Debentures.** Bancorp
      has a non-consolidated subsidiary trust, Severn Capital Trust I, of which 100%
      of the common equity is owned by Bancorp. The trust was formed for the purpose
      of issuing corporation-obligated mandatorily redeemable capital securities
      (“capital securities”) to third-party investors and investing the proceeds from
      the sale of such capital securities solely in subordinated debt securities
      of
      Bancorp (“debentures”). The debentures held by the trust are the sole assets of
      the trust. Distributions on the capital securities issued by the trust are
      payable quarterly at a rate per annum equal to the interest rate being earned
      by
      the trust on the debentures held by the trust. The capital securities are
      subject to mandatory redemption, in whole or in part, upon repayment of the
      debentures. Bancorp has entered into an agreement which, taken collectively,
      fully and unconditionally guarantees the capital securities subject to the
      terms
      of the guarantee. The debentures held by Severn Capital Trust I are first
      redeemable, in whole or in part, by Bancorp on January 7, 2010.





The
      subordinated debentures from Bancorp to the trust consist of a $20,619,000
      note,
      which is at a floating rate of interest of LIBOR (5.37% at December 31, 2006)
      plus 200 basis points, and matures in 2035.




**Off-Balance
      Sheet Arrangements** .
      Bancorp
      has certain outstanding commitments and obligations that could impact Bancorp’s
      financial condition, liquidity, revenues or expenses. These commitments and
      obligations include standby letters of credit, home equity lines of credit,
      loan
      commitments, lines of credit, and loans sold and serviced with limited
      repurchase provisions.





Standby
      letters of credit, which are obligations of Bancorp to guarantee performance
      of
      borrowers to governmental entities, decreased $585,000, or 8.8% as of December
      31, 2006 to $6,032,000, compared to $6,617,000 as of December 31, 2005. Bancorp
      continues to see demand by its borrowers for letter of credit
      requirements.





Construction
      loans in process decreased $31,492,000, or 23.1% as of December 31, 2006 to
      $104,747,000, compared to $136,239,000 as of December 31, 2005. Construction
      loan demand has decreased from 2005, and the amount of construction loans in
      process has decreased.





Home
      equity lines of credit increased $5,282,000, or 26.7%, as of December 31, 2006
      to $25,084,000, compared to $19,802,000 as of December 31, 2005. Home equity
      lines of credit allow the borrowers to draw funds up to a specified loan amount,
      from time to time. Bancorp’s management believes it has sufficient liquidity
      resources to have the funding available as these borrowers draw on these loans.
      This increase was a result of the competitively low interest rates offered
      on
      home equity loans.





Loan
      commitments decreased $4,700,000, or 24.1%, as of December 31, 2006 to
      $14,815,000, compared to $19,515,000 as of December 31, 2005. Loan commitments
      are obligations of Bancorp to provide loans, and such commitments are made
      in
      the usual course of business. This decrease was a result of a general slowdown
      in the demand for new loans at the end of 2006.





Lines
      of
      credit, which are obligations of Bancorp to fund loans made to certain
      borrowers, decreased $287,000, or 0.8%, to $33,495,000 as of December 31, 2006,
      compared to $33,782,000 as of December 31, 2005. The demand for this type of
      loan product has remained constant during 2006. Bancorp’s management believes it
      has sufficient liquidity resources to have the funding available as these
      borrowers draw on these loans.







44







Loans
      sold
      and serviced with limited repurchase provisions decreased $4,959,000, or 44.9%,
      as of December 31, 2006 to $6,089,000, compared to $11,048,000 as of December
      31, 2005. This decrease was the result of the slowdown in the market for loans
      sold on the secondary market.





Bancorp
      uses the same credit policies in making commitments and conditional obligations
      as it does for its on-balance sheet instruments.





**Comparison
      of Results of Operations for the Years Ended December 31, 2006 and
      2005.**





**General.** Bancorp’s
      net income for the year ended December 31, 2006 was $15,748,000, or $1.72 per
      share diluted. This is compared to $14,554,000, or $1.59 per share diluted
      in
      2005. This increase of $1,194,000, or 8.2%, was primarily the result of the
      growth in Bancorp’s mortgage portfolio and Bancorp’s continued ability to
      maintain low operating expenses.





**Net
      Interest Income.** Net
      interest income (interest earned net of interest charges) increased $2,935,000,
      or 8.3% to $38,115,000 for the year ended December 31, 2006, compared to
      $35,180,000 for the year ended December 31, 2005. This increase was primarily
      due to the growth in the loan portfolio, which offset a 0.15% decrease in
      Bancorp’s interest rate spread to 4.20% for the year ended December 31, 2006,
      compared to 4.35% for the year ended December 31, 2005. Bancorp’s interest rate
      spread decreased over the past year because interest rates earned on the Bank’s
      loans have risen slower than the rise in interest rates paid on the Bank’s
      interest bearing liabilities. Bancorp is uncertain whether it will be able
      to
      continue to attract lower cost deposits, as it has done in the last year, due
      to
      the general expectation of continued increased competition for deposit accounts
      and the possibility for interest rate increases in the future.





**Provision
      for Loan Losses.** The **** Bank’s
      loan portfolio is subject to varying degrees of credit risk and an allowance
      for
      loan losses is maintained to absorb losses inherent in its loan portfolio.
      Credit risk includes, but is not limited to, the potential for borrower default
      and the failure of collateral to be worth what the Bank determined it was worth
      at the time of the granting of the loan. The Bank monitors its loan portfolio
      at
      least as often as quarterly and its loan delinquencies at least as often as
      monthly. All loans that are delinquent and all loans within the various
      categories of the Bank’s portfolio as a group are evaluated. The Bank’s Board,
      with the advice and recommendation of the Bank’s delinquency committee,
      estimates an allowance to be set aside for loan losses. Included in determining
      the calculation are such factors as the inherent risk contained within the
      portfolio after considering the state of the general economy, economic trends,
      consideration of particular risks inherent in different kinds of lending and
      consideration of known information that may affect loan collectibility. An
      increase in the loan loss provision from the beginning of the year to the end
      of
      a year is the result after an analysis of the aforementioned factors and
      applying that rationale to the total portfolio.





As
      more
      commercial and higher loan-to-value loans are contained in the portfolio, the
      greater the allowance for loan losses will be. Changes in estimation methods
      may
      take place based upon the status of the economy and the estimate of the value
      of
      collateral and, as a result, the allowance may increase or decrease. The Bank
      believes that some portions of its loan portfolio have greater actual risk
      and,
      in other areas, there is greater inherent risk. The loan loss allowance has
      increased when the Board believes trends are negative and contributions to
      the
      allowance have decreased when trends are more positive. Management believes
      that
      the allowance for loan losses is adequate.





The
      total
      allowance for loan losses increased $1,521,000, or 20.3% to $9,026,000 as of
      December 31, 2006, compared to $7,505,000 as of December 31, 2005. The increase
      was a result of the current year’s addition to the allowance and minimal charge
      offs being incurred. During the year ended December 31, 2006, the provision
      for
      loan losses was $1,561,000 compared to $1,570,000 for the year ended December
      31, 2005. This decrease of $9,000 or 0.6%, was a result of slower loan growth
      and management’s determination that adding to the provision for loan losses was
      appropriate for the level of inherent risk in its portfolio as compared to
      the
      year ended December 31, 2005.




**Other
      Income and Non Interest Expenses.** Revenues
      from mortgage banking activities decreased $599,000, or 42.3% to $817,000 for
      the year ended December 31, 2006, compared to $1,416,000 for the year ended
      December 31, 2005. This decrease was primarily the result of a $159,000 decrease
      in mortgage processing and servicing fees and a $440,000 decrease in the gain
      on
      sale of loans for the year ended December 31, 2006 compared to the year ended
      December 31, 2005. These decreases were attributable to a general slowdown
      in
      loan activity, which resulted in fewer loans sold on the secondary market during
      2006 and less mortgage processing and servicing fees during 2006.







45







Real
      estate
      commissions increased $1,473,000, or 270.3% to $2,018,000 for the year ended
      December 31, 2006, compared to $545,000 for the year ended December 31, 2005.
      This increase was primarily the result of commissions earned on several large
      settlements that took place during 2006. Real estate management fees increased
      $152,000, or 35.7% for the year ended December 31, 2006, compared to $426,000
      for the year ended December 31, 2005. This increase was primarily due to
      additional properties being managed in 2006.





Other
      non-interest income increased $93,000, or 25.8% to $454,000 for the year ended
      December 31, 2006, compared to $361,000 for the year ended December 31,
      2005.  This
      increase was primarily a result of an increase in rents collected and savings
      charges.





Compensation
      and related expenses increased $1,254,000, or 13.8% to $10,334,000 for the
      year
      ended December 31, 2006, compared to $9,080,000 for the year ended December
      31,
      2005. This increase was the result of additional Bank employees hired, higher
      commissions paid on loan growth, and salary rate increases. As of December
      31,
      2006, Bancorp had 121 full-time equivalent employees compared to 111 at December
      31, 2005.





Occupancy
      decreased $13,000, or 1.8% to $706,000 for the year ended December 31, 2006,
      compared to $719,000 for the year ended December 31, 2005. Beginning in 2007,
      the Bank and Bancorp’s administrative offices will move to its new headquarters
      in a building owned by HS West, LLC. It is not expected that this move will
      have
      a material impact on occupancy costs.





Other
      non-interest expense decreased $54,000, or 1.8% to $3,025,000 for the year
      ended
      December 31, 2006, compared to $3,079,000 for the year ended December 31,
      2005.  This
      decrease was primarily a result of a one-time cash reconciliation charge off
      of
      $135,000 in 2005 and a decrease in miscellaneous expenses of approximately
      $67,000, partially offset by increases in professional fees of approximately
      $68,000 and an increase in advertising expenses of approximately
      $97,000.





**Income
      Taxes.** Income
      taxes increased $1,682,000, or 18.8% to $10,608,000 for the year ended December
      31, 2006, compared to $8,926,000 for the year ended December 31, 2005. The
      effective tax rate for the years ended December 31, 2006 and 2005 was 40.2%
      and
      38.0%, respectively.





**Comparison
      of Operating Results for the Years Ended December 31, 2005 and
      2004**





**General.** Bancorp’s net income for the year ended December 31, 2005 was $14,554,000, or
      $1.59 per share diluted. This is compared to $12,931,000, or $1.42 per share
      diluted for the year ended December 31, 2004. This increase of $1,623,000,
      or
      12.6%, was primarily the result of the continued growth in Bancorp’s mortgage
      portfolio coupled with Bancorp’s continued ability to maintain low operating
      expenses.





**Net
      Interest Income.** Net
      interest income (interest earned net of interest charges) totaled $35,180,000
      for the year ended December 31, 2005, compared to $30,198,000 for the year
      ended
      December 31, 2004, an increase of $4,982,000 or 16.5%. This increase was
      primarily due to the growth in the loan portfolio, which offset a .29% decrease
      in Bancorp’s interest rate spread to 4.35% for the year ended December 31, 2005,
      compared to 4.64% for the same period in 2004. Bancorp’s interest rate spread
      decreased during 2005 year because interest rates earned on the Bank’s loans had
      risen slower than the rise in interest rates paid on the Bank’s interest bearing
      liabilities.




**Provision
      for Loan Losses.** As of
      December 31, 2005, the total allowance for loan losses was $7,505,000 as
      compared to $5,935,000 as of December 31, 2004, which was an increase of
      $1,570,000, or 26.5%. The increase was a result of the 2005 addition to the
      allowance and no charge offs being incurred. During the year ended December
      31,
      2005, the provision for loan losses was $1,570,000 compared to $1,200,000 for
      the year ended December 31, 2004. This increase of $370,000 or 30.8%, was a
      result of increased loan growth and management’s determination that adding to
      the provision for loan losses was appropriate for the level of inherent risk
      in
      its portfolio as compared to the year ended December 31, 2004.


46





**Other
      Income and Non Interest Expenses.** Mortgage
      banking activities decreased $19,000, or 1.3% to $1,416,000 for the year ended
      December 31, 2005, compared to $1,435,000 for the year ended December 31, 2004.
      This decrease was primarily the result of a $32,000 decrease in mortgage
      processing and servicing fees partially offset by a $13,000 increase in the
      gain
      on sale of loans for the year ended December 31, 2005 compared to the year
      ended
      December 31, 2004. The increase in the gain on sale of loans was attributable
      to
      increased amount of loans sold on the secondary market during 2005. The decrease
      in mortgage processing and servicing fees related to a slowdown during 2005
      of
      residential mortgages being refinanced.





Real
      estate commissions totaled $545,000 for the year ended December 31, 2005,
      compared to $1,234,000 for the year ended December 31, 2004, a decrease of
      $689,000 or 55.8%. This decrease was primarily due to a slowdown in commercial
      property sales and leasing. Real estate management fees totaled $426,000 for
      the
      year ended December 31, 2005, compared to $404,000 for the year ended December
      31, 2004, an increase of $22,000 or 5.4%. This increase was primarily due to
      an
      increase in the amount of managed real estate.





Other
      non-interest income totaled $361,000 for the year ended December 31, 2005,
      compared to $329,000 for the year ended December 31, 2004, an increase of
      $32,000, or 9.7%.  This
      increase was primarily a result of an increase in fees collected on loans.





Compensation
      and related expenses totaled $9,080,000 for the year ended December 31, 2005,
      compared to $8,167,000 for the year ended December 31, 2004, an increase of
      $913,000 or 11.2%. This increase was the result of hiring additional Bank
      employees, higher commissions paid on loan growth, and salary rate increases.
      As
      of December 31, 2005, Bancorp had 111 full-time equivalent employees compared
      to
      95 at December 31, 2004.





Other
      non-interest expense totaled $3,079,000 for the year ended December 31, 2005,
      compared to $2,434,000 for the year ended December 31, 2004, an increase of
      $645,000, or 26.5%.  This
      increase was primarily a result of increases in professional fees of $183,000,
      a
      cash reconciliation charge off of approximately $135,000 and an increase in
      office expenses of approximately $75,000.





**Income
      taxes** .
      Income
      taxes for the year ended December 31, 2005 were $8,926,000, compared to
      $8,258,000 for the year ended December 31, 2004, an increase of $668,000 or
      8.1%. The effective tax rate for the years ended December 31, 2005 and 2004
      was
      38.0% and 39.0%, respectively.




**Liquidity
      and Capital Resources.**





Bancorp’s
      liquidity is determined by its ability to raise funds through loan payments,
      maturing investments, deposits, borrowed funds, capital, or the sale of loans.
      Based on the internal and external sources available, Bancorp’s liquidity
      position exceeded anticipated short-term and long-term needs at December 31,
      2006. Core deposits, considered to be stable funding sources and defined to
      include all deposits except time deposits of $100,000 or more, equaled 68%
      of
      total deposits at December 31, 2006. The Bank’s experience is that a substantial
      portion of certificates of deposit will renew at time of maturity and will
      remain on deposit with the Bank. Additionally, loan payments, maturities,
      deposit growth and earnings contribute a flow of funds available to meet
      liquidity requirements.





In
      addition to its ability to generate deposits, Bancorp has external sources
      of
      funds, which may be drawn upon when desired. The primary source of external
      liquidity is an available line of credit equal to 30% of the Bank’s assets with
      FHLB-Atlanta. The available line of credit with FHLB-Atlanta was $273,575,000
      at
      December 31, 2006, of which $173,000,000 was outstanding at that time. For
      interest rates on these advances, see note 7 to the consolidated financial
      statements.





In
      assessing its liquidity the management of Bancorp considers operating
      requirements, anticipated deposit flows, expected funding of loans, deposit
      maturities and borrowing availability, so that sufficient funds may be available
      on short notice to meet obligations and business opportunities as they arise.
      As
      of December 31, 2006, Bancorp had $14,815,000 outstanding in loan commitments,
      which Bancorp expects to fund from the sources of liquidity described above.
      This amount does not include undisbursed lines of credit, home equity lines
      of
      credit and standby letters of credit, in the aggregate amount of $64,611,000,
      which Bancorp anticipates it will be able to fund, if required, from these
      liquidity sources in the regular course of business.







47







In
      addition
      to the foregoing, the payment of dividends is a use of cash, but is not expected
      to have a material effect on liquidity.





The
      Bank
      is subject to various regulatory capital requirements administered by the
      federal banking agencies. Failure to meet minimum capital requirements can
      initiate certain mandatory, and possible additional discretionary, actions
      by
      the regulators that, if undertaken, could have a direct material effect on
      the
      Bank’s financial statements. Under capital adequacy guidelines and the
      regulatory framework for prompt corrective action, the Bank must meet specific
      capital guidelines that involve quantitative measures of the Bank’s assets,
      liabilities, and certain off-balance sheet items as calculated under regulatory
      accounting practices. The Bank’s capital amounts and classifications are also
      subject to qualitative judgments by the regulators about components, risk
      weightings, and other factors.  Management
      believes, as of December 31, 2006, that the Bank meets all capital adequacy
      requirements to which it is subject.





**Contractual
      Obligations**





The
      following table contains for the periods indicated information regarding the
      financial obligations owing by Bancorp under contractual
      obligations.





**Payments
                due by period**
              (dollars
                in thousands)**Total**
            
            **2007**
            
            **2008-2009**
            
            **2010-2011**
            
            **2012
                +**Long
                term debt
            
            $
            155,000
            
            $
            15,000
            
            $
            35,000
            
            $
            10,000
            
            $
            95,000Subordinated
                debentures
            
            
            20,619
            
            
            -
            
            
            -
            
            
            -
            
            
            20,619Operating
                lease obligations
            
            
            214
            
            
            60
            
            
            120
            
            
            34
            
            
            -Certificates
                of Deposit
            
            
            490,865
            
            
            409,469
            
            
            50,842
            
            
            30,509
            
            
            45Total
            
            $
            666,698
            
            $
            424,529
            
            $
            85,962
            
            $
            40,543
            
            $
            115,664








**Item
      7A. Quantitative and Qualitative Disclosures About Market
      Risk**





**Qualitative
      Information About Market Risk.** The
      principal objective of Bancorp’s interest rate risk management is to evaluate
      the interest rate risk included in balance sheet accounts, determine the level
      of risks appropriate given Bancorp’s business strategy, operating environment,
      capital and liquidity requirements and performance objectives, and manage the
      risk consistent with Bancorp’s interest rate risk management policy. Through
      this management, Bancorp seeks to reduce the vulnerability of its operations
      to
      changes in interest rates. The Board of Directors of Bancorp is responsible
      for
      reviewing assets/liability policies and interest rate risk position. The Board
      of Directors reviews the interest rate risk position on a quarterly basis and,
      in connection with this review, evaluates Bancorp’s business activities and
      strategies, the effect of those strategies on Bancorp’s net interest margin and
      the effect that changes in interest rates will have on Bancorp’s loan portfolio.
      While continuous movement of interest rates is certain, the extent and timing
      of
      these movements is not always predictable. Any movement in interest rates has
      an
      effect on Bancorp’s profitability. Bancorp faces the risk that rising interest
      rates could cause the cost of **** interest
      bearing liabilities, such as deposits and borrowings, to rise faster than the
      yield on interest earning assets, such as loans and investments. Bancorp’s
      interest rate spread and interest rate margin may be negatively impacted in
      a
      declining interest rate environment even though Bancorp generally borrows at
      short-term interest rates and lends at longer-term interest rates. This is
      because loans and other interest earning assets may be prepaid and replaced
      with
      lower yielding assets before the supporting interest bearing liabilities reprice
      downward. Bancorp’s interest rate margin may also be negatively impacted in a
      flat or inverse-yield curve environment. Mortgage origination activity tends
      to
      increase when interest rates trend lower and decrease when interest rates
      rise.







48







Bancorp’s
      primary strategy to control interest rate risk is to sell substantially all
      long-term fixed-rate loans in the secondary market. To further control interest
      rate risk related to its loan servicing portfolio, Bancorp originates a
      substantial amount of construction loans that typically have terms of one year
      or less. The turnover in construction loan portfolio assists Bancorp in
      maintaining a reasonable level of interest rate risk.





**Quantitative
      Information About Market Risk.** The
      primary market risk facing Bancorp is interest rate risk. From an enterprise
      prospective, Bancorp manages this risk by striving to balance its loan
      origination activities with the interest rate market. Bancorp attempts to
      maintain a substantial portion of its loan portfolio in short-term loans such
      as
      construction loans. This has proven to be an effective hedge against rapid
      increases in interest rates as the construction loan portfolio reprices
      rapidly.





The
      matching of maturity or repricing of interest earning assets and interest
      bearing liabilities may be analyzed by examining the extent to which these
      assets and liabilities are interest rate sensitive and by monitoring the Bank’s
      interest rate sensitivity gap. An interest earning asset or interest bearing
      liability is interest rate sensitive within a specific time period if it will
      mature or reprice within that time period. The difference between rate sensitive
      assets and rate sensitive liabilities represents the Bank’s interest sensitivity
      gap.





Exposure
      to interest rate risk is actively monitored by Bancorp’s management. Its
      objective is to maintain a consistent level of profitability within acceptable
      risk tolerances across a board range of potential interest rate environments.
      Bancorp uses the OTS Net Portfolio Value (“NPV”) model to monitor its exposure
      to interest rate risk, which calculates changes in NPV. The following table
      represents Bancorp’s NPV at December 31, 2006. The NPV was calculated by the
      OTS, based upon information provided to the OTS.





INTEREST
      RATE SENSITIVITY OF NET PORTFOLIO VALUE (NPV)




Net
                Portfolio Value
            NPV
                as % of PV of AssetsChange
                In Rates
            $
                Amount
            $
                Change
            %
                Change
            NPV
                Ratio
            Change(dollars
                are in thousands)+300
                bp
            108,903
            (17,518)
            (14%)
            12.22%
            (148bp)+200
                bp
            115,804
            (10,617)
            (8%)
            12.83%
            (87bp)+100
                bp
            121,130
            (5,292)
            (4%)
            13.27%
            (42bp)0
                bp
            126,421
            
            
            13.69%-100
                bp
            130,260
            3,838
            3%
            13.96%
            27bp-200
                bp
            132,417
            5,995
            5%
            14.05%
            36bp-300
                bp
            -
            -
            -%
            -%
            -bp





The
      above
      table suggests that if interest rates rise 100 bps, Bancorp’s interest sensitive
      assets would decline by $5,292,000.







**Item
      8. Financial Statements and Supplementary Data**





Financial
      statements and supplementary data are included herein at pages F1 through F35
      .








**Item
      9. Changes in and Disagreements with Accountants on Accounting and Financial
      Disclosure**





None.













49




**Item
      9A. Controls and Procedures**





Under
      the
      supervision and with the participation of Bancorp's management, including its
      Chief Executive Officer and Chief Financial Officer, Bancorp has evaluated
      the
      effectiveness of its disclosure controls and procedures (as defined in
      Securities Exchange Act Rule 13a-15(e)) as of December 31, 2006. Based upon
      this
      evaluation, the Chief Executive Officer and Chief Financial Officer have
      concluded that, as of the period covered by this report, Bancorp’s disclosure
      controls and procedures were effective in reaching a reasonable level of
      assurance that (i) information required to be disclosed by Bancorp in the
      reports that it files or submits under the Securities Exchange Act of 1934
      is
      recorded, processed, summarized and reported within the time periods specified
      in the Securities and Exchange Commission’s rules and forms and (ii) information
      required to be disclosed by Bancorp in its reports that it files or submits
      under the Securities Exchange Act of 1934 is accumulated and communicated to
      its
      management, including its principal executive and principal financial officers,
      or persons performing similar functions, as appropriate to allow timely
      decisions regarding required disclosure.





Bancorp’s
      management, with the participation of its Chief Executive Officer and Chief
      Financial Officer, also conducted an evaluation of Bancorp’s internal control
      over financial reporting, as defined in Exchange Act Rule 13a-15(f), to
      determine whether any changes occurred during the quarter ended December 31,
      2006, that have materially affected, or are reasonably likely to materially
      affect, Bancorp’s internal control over financial reporting. Based on that
      evaluation, there were no such changes during the quarter ended December 31,
      2006.





A
      control
      system, no matter how well conceived and operated, can provide only reasonable,
      not absolute, assurance that the objectives of the control system are met.
      Further, the design of a control system must reflect the fact that there are
      resource constraints, and the benefits of controls must be considered relative
      to their costs. Because of the inherent limitations in all control systems,
      no
      evaluation of controls can provide absolute assurance that all control issues
      and instances of fraud, if any, within Bancorp have been detected. Because
      of
      the inherent limitations in a cost-effective control system, misstatements
      due
      to error or fraud may occur and not be detected.














































50

















MANAGEMENT’S
      REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING








Severn
      Bancorp, Inc. (“Bancorp”) is responsible for the preparation, integrity, and
      fair presentation of the consolidated financial statements included in this
      annual report. The consolidated financial statements and notes included in
      this
      annual report have been prepared in conformity with United States generally
      accepted accounting principals, and as such, include some amounts that are
      based
      on management’s best estimates and judgments.





Bancorp’s
      management is responsible for establishing and maintaining effective internal
      control over financial reporting. The system of internal control over financial
      reporting, as it relates to the financial statements, is evaluated for
      effectiveness by management and tested for reliability through a program of
      internal audits and management testing and review. Actions are taken to correct
      potential deficiencies as they are identified. Any system of internal control,
      no matter how well designed, has inherent limitations, including the possibility
      that a control can be circumvented or overridden and misstatements due to error
      or fraud may occur and not be detected. Also, because of changes in conditions,
      internal control effectiveness may vary over time. Accordingly, even an
      effective system of internal control will provide only reasonable assurance
      with
      respect to financial statement preparation.





Management
      assessed the effectiveness of Bancorp’s internal control over financial
      reporting as of December 31, 2006. In making this assessment, it used the
      criteria set forth by the Committee of Sponsorship Organizations of the Treadway
      Commission (COSO) in *Internal
      Control - Integrated*  *Framework* .
      Based
      on its assessment, management concluded that as of December 31, 2006, Bancorp’s
      internal control over financial reporting is effective and meets the criteria
      of
      the *Internal
      Control* - *Integrated
      Framework* .





Bancorp’s
      independent registered public accounting firm, Beard Miller Company LLP, has
      issued as attestation report on management’s assessment of Bancorp’s internal
      control over financial reporting. This report appears on pages 50 and
      51.






































/s/
                Alan J. Hyatt
            
            /s/
                Thomas G. BevivinoAlan
                J. Hyatt
            
            Thomas
                G. BevivinoPresident
                and Chief Executive Officer
            
            Principal
                Financial Officer





51







Report
        of
        Independent Registered Public Accounting Firm
 
 
 
 To
        the
        Board of Directors and
 Stockholders
        of Severn Bancorp, Inc.
 
 
 We
        have
        audited management’s assessment, included in the accompanying Management’s
        Report on Internal Control Over Financial Reporting, that Severn Bancorp,
        Inc.
        and Subsidiaries maintained effective internal control over financial reporting
        as of December 31, 2006, based on criteria established in *Internal
        Control-Integrated Framework* issued
        by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
        The Corporation’s management is responsible for maintaining effective internal
        control over financial reporting and for its assessment of the effectiveness
        of
        internal control over financial reporting. Our responsibility is to express
        an
        opinion on management’s assessment and an opinion on the effectiveness of the
        company’s internal control over financial reporting based on our
        audit.
 
 We
        conducted our audit in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether effective
        internal control over financial reporting was maintained in all material
        respects. Our audit included obtaining an understanding of internal control
        over
        financial reporting, evaluating management’s assessment, testing and evaluating
        the design and operating effectiveness of internal control, and performing
        such
        other procedures as we considered necessary in the circumstances. We believe
        that our audit provides a reasonable basis for our opinion.
 
 A
        company’s internal control over financial reporting is a process designed to
        provide reasonable assurance regarding the reliability of financial reporting
        and the preparation of financial statements for external purposes in accordance
        with generally accepted accounting principles. A company’s internal control over
        financial reporting includes those policies and procedures that (1) pertain
        to
        the maintenance of records that, in reasonable detail, accurately and fairly
        reflect the transactions and dispositions of the assets of the company; (2)
        provide reasonable assurance that transactions are recorded as necessary
        to
        permit preparation of financial statements in accordance with generally accepted
        accounting principles, and that receipts and expenditures of the company
        are
        being made only in accordance with authorizations of management and directors
        of
        the company; and (3) provide reasonable assurance regarding prevention or
        timely
        detection of unauthorized acquisition, use, or disposition of the company’s
        assets that could have a material effect on the financial
        statements.
 
 Because
        of its inherent limitations, internal control over financial reporting may
        not
        prevent or detect misstatements. Also, projections of any evaluation of
        effectiveness to future periods are subject to the risk that controls may
        become
        inadequate because of changes in conditions, or that the degree of compliance
        with the policies or procedures may deteriorate.
 
 52
  In
        our
        opinion, management’s assessment that Severn Bancorp, Inc. and Subsidiaries
        maintained effective internal control over financial reporting as of December
        31, 2006, is fairly stated, in all material respects, based on criteria
        established in *Internal
        Control-Integrated Framework* issued
        by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
        Also, in our opinion, Severn Bancorp, Inc. and Subsidiaries maintained, in
        all
        material respects, effective internal control over financial reporting as
        of
        December 31, 2006, based on criteria established in *Internal
        Control-Integrated Framework* issued
        by the Committee of Sponsoring Organizations of the Treadway Commission
        (COSO).
 
 We
        have
        also audited, in accordance with the standards of the Public Company Accounting
        Oversight Board (United States), the consolidated financial statements of
        Severn
        Bancorp, Inc. and Subsidiaries as of and for the year ended December 31,
        2006
        and our report dated March 6, 2007 expressed an unqualified opinion on those
        financial statements.
 
 
 
  Beard
        Miller Company LLP
 Baltimore,
        Maryland
 March
        6,
        2007








53







**Item
      9B. Other Information**





Bancorp
      does not have any employees. The executive officers of Bancorp are employees
      at-will of the Bank. The Board of Directors of the Bank has a Compensation
      Committee, which determines the compensation of the executive officers of
      Bancorp. Annually, the Compensation Committee of the Bank’s Board of Directors
      evaluates profiles of comparable financial institutions to assure that the
      compensation to its executive officers is comparable to its peer group. Other
      factors used by the Compensation Committee in determining compensation for
      its
      executive officers include an assessment of the overall financial condition
      of
      the Bank, including an analysis of the Bank’s asset quality, interest rate risk
      exposure, capital position, net income and consistency of earnings. The Bank’s
      return on average assets and return on equity is considered and compared to
      its
      peer group. The complexity of the activities of the executive officers are
      considered, and intangible items are considered such as the reputation and
      general standing of the Bank within the community and the likelihood of
      continuing successful and profitable results.





Based
      on
      the considerations set forth above, at its meeting on  November
      21, 2006,  the
      Compensation Committee approved bonuses for the Bank’s executive officers for
      fiscal year 2006 as follows: Alan J. Hyatt, $191,000; Melvin E. Meekins, Jr.,
      $135,300; S. Scott Kirkley, $82,500; and Thomas G. Bevivino, $50,000. In
      addition, the Compensation Committee, at its meeting on  November
      21, 2006, approved the annual base salaries of the Bank’s executive officers for
      fiscal year 2007 as follows: Alan J. Hyatt, $278,000; Melvin E. Meekins, Jr.,
      $330,000; S. Scott Kirkley, $236,000; and Thomas G. Bevivino,
      $167,000.










**PART
      III**





**Item
      10. Directors and Executive Officers of the Registrant and Corporate
      Governance**





Reference
      is made to the section captioned “Proposal 1: Election of Directors” in
      Bancorp's Proxy Statement dated March 21, 2007 for the information required
      by
      this Item, which is hereby incorporated by reference.





Reference
      is made to the section captioned “Stock Ownership” in Bancorp’s Proxy Statement
      dated March 21, 2007 for the information required by this Item, which is hereby
      incorporated by reference.





Reference
      is made to the section captioned “”Section 16(a) Beneficial Ownership Reporting
      Compliance” in Bancorp’s Proxy Statement dated March 21, 2007 for the
      information required by this Item, which is hereby incorporated by
      reference.





**Item
      11. Executive Compensation**





Reference
      is made to the section captioned “Director and Executive Officer Compensation”
in Bancorp's Proxy Statement dated March 21, 2007 for the information required
      by this Item, which is hereby incorporated by reference.










54





**Item
      12. Security Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters**





Reference
      is made to the section captioned “Stock Ownership” and “Director and Executive
      Officer Compensation” in Bancorp's Proxy Statement dated March 21, 2007 for the
      information required by this Item, which is hereby incorporated by
      reference.








**Number
                of**
            
            
            
            **Number
                of****securities
                to be**
            
            
            
            **securities****issued
                upon**
            
            **Weighted-average**
            
            **remaining
                available****exercise
                of**
            
            **exercise
                price of**
            
            **for
                future issuance****outstanding**
            
            **outstanding**
            
            **Under
                equity****options,
                warrants**
            
            **options,
                warrants**
            
            **compensation****Plan
                Category**
            
            **and
                rights**
            
            **and
                rights**
            
            **plans****Equity
                compensation plan approved by****security
                holders**
            
            112,400
            
            $17.43
            
            45,100**Equity
                compensation****plans
                not approved by security holders**
            
            -
            
            -
            
            -**Total**
            
            112,400
            
            $17.43
            
            45,100








**Item
      13. Certain Relationships and Related Transactions, and Director
      Independence**





Reference
      is made to the sections captioned “Compensation Committee Interlocks, and
      Insider Participation,” and “Certain Transactions With Related Persons” in
      Bancorp's Proxy Statement dated March 21, 2007 for the information required
      by
      this Item, which is hereby incorporated by reference.





Reference
      is made to the section captioned “Director Independence” in Bancorp’s Proxy
      Statement dated March 21, 2007 for the information required by this Item, which
      is hereby incorporated by reference.





**Item
      14. Principal Accountant Fees and Services**





Reference
      is made to the section captioned “Relationship with Independent Auditors” in
      Bancorp's Proxy Statement dated March 21, 2007 for the information required
      by
      this Item, which is hereby incorporated by reference.













55




**PART
      IV**





**Item
      15. Exhibits and Financial Statement Schedules**





(a)  The
      following consolidated financial statements of Bancorp and its wholly owned
      sub-sidiaries are filed as part of this report:





1.  Financial
      Statements


·  REPORTS
      OF BEARD MILLER COMPANY LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING
      FIRM.


·  CONSOLIDATED
      STATEMENTS OF FINANCIAL CONDITION AT DECEMBER 31, 2006 AND DECEMBER 31, 2005


·  CONSOLIDATED
      STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND
      2004


·  CONSOLIDATED
      STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND
      2004


·  CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2006, 2005
      AND 2004.


·  NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS





2.  Financial
      Statement Schedules


All
      financial statement schedules have been omitted, as required information is
      either inapplicable or included in the consolidated financial statements or
      related notes.




3.  Exhibits


The
      following exhibits are filed as part of this report:





**Exhibit
      No.**  **Description
      of Exhibit**




3.1
              Articles
                  of Incorporation of Severn Bancorp, Inc.(1)3.2
              Bylaws
                  of Severn Bancorp, Inc.(1)3.3
              Amendment
                  to Bylaws10.1+
              Description
                  of compensation of directors and officers10.2+
              Stock
                  Option Plan(3)10.3+
              Employee
                  Stock Ownership Plan(1)10.4+
              Form
                  of Common Stock Option Agreement(4)14
              Code
                  of Ethics(2)21.1
              Subsidiaries
                  of Severn Bancorp, Inc.23.1
              Consent
                  of Independent Registered Public Accounting Firm31.1
              Certification
                  of CEO pursuant to Section 302 of Sarbanes-Oxley Act of
                  200231.2
              Certification
                  of CFO pursuant to Section 302 of Sarbanes-Oxley Act of
                  200232
              Certification
                  of CEO and CFO pursuant to Section 906 of Sarbanes-Oxley Act of
                  2002





+
      Denotes
      management contract, compensatory plan or arrangement.


(1)  Incorporated
      by reference from Bancorp's Registration Statement of Form 10 filed with the
      Securities and Exchange Commission on June 7, 2002.


(2)  Incorporated
      by reference from Bancorp's 2003 Form 10-K filed with the Securities and
      Exchange Commission on March 25, 2004.


(3)  Incorporated
      by reference from Bancorp's 2004 Form 10-K filed with the Securities and
      Exchange Commission on March 21, 2005.


(4)  Incorporated
      by reference from Bancorp’s Current Report on Form 8-K filed with the Securities
      and Exchange Commission on March 20, 2006.








56





**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.




SEVERN
                  BANCORP, INC.March
                  6, 2007
              /s/
                  Alan J. HyattAlan
                  J. HyattChairman
                  of the Board, President,Chief
                  Executive Officer and
                  Director


57





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the dates indicated.




March
                  6, 2007
              /s/
                  Alan J. HyattAlan
                  J. HyattChairman
                  of the Board,President,
                  Chief Executive Officerand
                  DirectorMarch
                  6, 2007
              /s/
                  Thomas G. BevivinoThomas
                  G. Bevivino, Executive VicePresident
                  and Chief Financial OfficerMarch
                  6, 2007
              /s/
                  S. Scott KirkleyS.
                  Scott Kirkley, Executive VicePresident,
                  Secretary, Treasurer and DirectorMarch
                  6, 2007
              /s/
                  Melvin E. Meekins, Jr.Melvin
                  E. Meekins, Jr., ExecutiveVice
                  President and DirectorMarch
                  6, 2007
              */s/*Melvin
                  HyattMelvin
                  Hyatt, DirectorMarch
                  6, 2007
              /s/
                  Ronald P. PenningtonRonald
                  P. Pennington, DirectorMarch
                  6, 2007
              /s/
                  T. Theodore SchultzT.
                  Theodore Schultz, DirectorMarch
                  6, 2007
              /s/
                  Albert W. ShieldsAlbert
                  W. Shields, DirectorMarch
                  6, 2007
              /s/
                  Louis DiPasquale, Jr.Louis
                  DiPasquale, Jr., DirectorMarch
                  6, 2007
              /s/
                  Keith StockKeith
                  Stock, Director